Earnings Call Transcript - MZTI Q3 2023

Operator (Carmen), Operator / Conference Call Facilitator

Good morning. My name is Carmen, 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 Third Quarter Conference Call. Conducting today’s call will be Dave Ciesinski, President and CEO; and Tom Pigott, CFO. Operator provided instructions. And now to begin the conference call, here is Dale Ganobsik, Vice President of Corporate Finance and Investor Relations for Lancaster Colony Corporation.

Dale Ganobsik, Vice President, Corporate Finance & Investor Relations

Good morning everyone and thank you for joining us today for Lancaster Colony’s fiscal year 2023 third 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 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 strategy and outlook. 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, President and Chief Executive Officer

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 2023. In our fiscal third quarter, which ended March 31, we were pleased to report both record sales and higher profits. Consolidated net sales increased 15.2% to $465 million, while consolidated gross profit improved 37.9% to $94.2 million. Operating income reached $29.4 million compared to an operating loss of $7.6 million last year. Prior year operating income included a restructuring and impairment charge of $22.7 million. The Retail segment reported Q3 net sales of $247 million, up 16% and driven by the favorable impact of pricing actions to offset inflation and strong volume growth of 6%. The volume growth measured in pounds shipped was driven by the continued success of our licensing program and double-digit growth for our New York Bakery frozen garlic bread products. In licensing, Buffalo Wild Wings sauces, RV sauces, Chick-fil-A sauces and Olive Garden dressings all contributed to volume growth. IRI data for our fiscal third quarter showed sales gains from marquee retail brands and notable share gains for our category-leading New York Bakery and Sister Schubert brands. New York Bakery’s leading share of the frozen garlic bread category grew 350 basis points to 43.5%. Sister Schubert’s leading share of the frozen dinner roll category increased 150 basis points to 53.1%. In our Foodservice segment, net sales grew over 14% to $218 million, driven by pricing actions, volume gains for several national account customers and higher demand for our branded foodservice products. In total, Foodservice segment volume increased less than 1%. Excluding the sales of some less profitable product lines that were discontinued during the past year, foodservice volume was up over 4%. During Q3, we continued to experience high levels of inflation for raw materials and packaging. That said, through the benefit of our pricing actions, PNOC, or pricing net of commodities, was favorable versus the prior year. This is a continuation of the trend that began in Q1 of this year in which we were recovering some of the negative PNOC we experienced last year. We also benefited from another quarter of sequential improvement in cost savings attributed to productivity gains. In the quarters ahead, we will maintain our focus on supply chain productivity, value engineering and revenue management to improve our financial performance. Before I turn it over to Tom, I’d like to extend my sincere thanks to the entire Lancaster Colony team for their ongoing commitment and contributions to our improved operational and financial performance. I’ll now turn the call over to Tom Pigott, our CFO, for his commentary on our third quarter results. Tom?

Tom Pigott, Chief Financial Officer

Thanks, Dave. Overall, the results for the quarter reflected continued top- and bottom-line growth driven by pricing actions that offset inflationary costs, improved supply chain performance and strong volume growth versus the prior year quarter. Third quarter net sales increased by 15.2% to $464.9 million. This growth was driven by pricing and volume. Decomposing the 15.2% increase in revenue, 11.3 percentage points were driven by pricing with the remaining 3.9 percentage points driven by volume and a more favorable sales mix. Consolidated gross profit increased by $25.9 million or 37.9% to $94.2 million. The increase in gross profit reflected favorable PNOC, improved supply chain performance and higher volume. If you recall, in Q3 of fiscal ’22, we had negative PNOC as we absorbed the rapid run-up in costs. We continue to recover those losses—while our commodity inflation was approximately 20% this quarter, our pricing actions offset this increase and the prior year shortfall. As it relates to the improved supply chain performance, in the prior year quarter we experienced a high level of supply chain disruption resulting in higher costs. This quarter, execution improved, and the company generated cost savings that contributed to the improved gross profit performance. Finally, both segments reported volume growth despite the impact of the product discontinuations. Selling, general and administrative expenses increased 18.9% or $10.3 million. The increase reflects higher incentive compensation, investments to support the growth of the business and charges resulting from the settlement of lawsuits. The investments to support the growth of the business included higher consumer spending and increased brokerage costs. Consumer spending is increasing in the second half to drive volume growth as our product supply position has improved. Expenditures for Project Ascent, our ERP initiative, were down as the project progressed into its later stages. Costs related to the project totaled $7.6 million in the current year quarter versus $10.3 million in the prior year quarter. Consolidated operating income increased $37 million to $29.4 million. In the prior year quarter, we recorded noncash restructuring and impairment charges and a benefit for changes in contingent consideration. Together, they netted to a $21.4 million expense. Excluding these items, operating income increased due to strong gross profit growth of the business, partially offset by the higher SG&A costs. Our tax rate for the quarter was 18.2% versus 40.2% in the prior year quarter. We estimate our tax rate for the fourth quarter to be 23%. Third quarter diluted earnings per share decreased $0.06 to $0.89 per share reported. The increase versus the prior year was primarily driven by the two noncash charges in the prior year that I mentioned, which totaled $0.59, and the improvement in the underlying performance of the business. The reduction in Project Ascent expenses contributed $0.08 to the EPS growth versus the prior year quarter. With regard to capital expenditures, payments for property additions in the third quarter totaled $22.4 million. For fiscal year 2023, we are forecasting total capital expenditures of approximately $100 million. This forecast includes approximately $55 million for the completion of the Horse Cave expansion project. In addition to investing in our business, we also returned funds to shareholders. Our quarterly cash dividend of $0.85 per share paid on March 31 represented a 6% increase from the prior year’s amount. Our enduring streak of annual dividend increases stands at 60 years. Our financial position remains strong as we are debt-free with $82.9 million of cash on the balance sheet. So to wrap up my commentary, our third quarter results reflected improved performance in several areas, resulting in very strong profit growth. I will now turn it back over to Dave for his closing remarks. Thank you.

Dave Ciesinski, President and Chief Executive Officer

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: one, accelerate core business growth; two, simplify our supply chain to reduce our cost and grow our margins; and three, expand our core with focused M&A and strategic licensing. In our fiscal fourth quarter, we anticipate retail sales to benefit from our licensing program and incremental growth from new products, flavors and sizes that we introduced this fiscal year. And in foodservice, we expect continued volume growth from several of our national chain restaurant customers. It’s worth noting that our consolidated net sales will compare to last year’s fourth quarter that benefited from an estimated $25 million in incremental net sales attributed to the advanced customer orders ahead of our July 1 ERP go-live date for Wave 1. Cost inflation will remain a headwind to our financial results, but we expect our pricing actions and cost savings initiatives to offset the increased cost. Finally, I’d like to provide you with an update on the implementation phase of our ERP initiative, Project Ascent. As we shared previously, this past July we successfully completed Wave 1 of the implementation—and in October we completed Wave 2. During our fiscal third quarter, we successfully completed Wave 3 of the implementation, adding our largest dressing and sauce production facility in Horse Cave, Kentucky to the new system. The implementation went as planned, but as expected, we did incur some incremental cost as production and service were unfavorably impacted by the ERP system cutover process. I’m happy to report that the team has successfully addressed those issues. We expect to complete the final wave of Project Ascent in the coming months with the implementation phase scheduled to conclude during our fiscal first quarter. I would like to extend my sincere thanks to all of my teammates for their ongoing efforts on this important strategic initiative. This concludes our prepared remarks for today and we would be happy to answer any questions you might have.

Operator, Operator

Thank you. Operator provided instructions. And it comes from the line of Todd Brooks with The Benchmark Company. Please go ahead.

Todd Brooks, Analyst (The Benchmark Company)

Hey, thanks. Good morning, everybody.

Dave Ciesinski, President and Chief Executive Officer

Good morning.

Tom Pigott, Chief Financial Officer

Good morning.

Todd Brooks, Analyst (The Benchmark Company)

A couple of questions for me, if I may. One, can we dive into the SG&A spend a little bit. I’d love to get some color going forward, maybe what the legal charges that were in that total? And then talk about maybe the higher level of customer spending that was expected in the back half of the year, if that was either outsized versus prior expectations or if we just were too conservative in our modeling of G&A?

Tom Pigott, Chief Financial Officer

Okay, Todd. So I’ll take you through that. In the quarter, the incentive compensation increase year-over-year was $4 million. Last year, the financial performance of the business was below the overall company’s expectations, and this year it’s exceeding, so that $4 million is more of a transitory item that is kind of a catch-up for the first half of the year as well as the third quarter. The legal settlements were related to closed businesses and that was $2 million. So that $6 million is more transitory in nature. Then when you get into the next bucket, we’re really talking about the things that invest to grow. The consumer spending was up $1 million and the brokerage was up a couple of million dollars. And then the last driver I’ll touch on is really the SAP costs in the core business, and that’s the amortization and the licensing costs from going live on the new software. Those are the key items I want to hit on. In terms of the outlook for Q4, we’re going to continue to invest to grow to support the business. So we do expect the consumer spend to be sequentially higher than last year as their supply position has improved, and we continue to want to drive volume growth. We will continue to spend on Ascent. Some of those transitory costs, particularly the legal and some of the bonus, won’t be repeating. So sequentially, we do expect the overall spend to decline in the fourth quarter.

Todd Brooks, Analyst (The Benchmark Company)

Perfect. That’s really helpful. Thanks. And then my final question and I’ll jump back in queue. And this is just trying to level set everybody. So Dave, you teased out the $25 million that we’re up against in this quarter that was a pull forward. But you also talked in the release about some potential pull forward into the March quarter from just Easter timing and the Easter shift. Is there an impact that we think about as we’re thinking about the Retail segment based on that timing? Maybe what type of revenue do you estimate was pulled forward into the market?

Dave Ciesinski, President and Chief Executive Officer

First, Todd, I’ll start just talking about Q3, and then maybe we will talk about the outlook for Q4. For Q3, Easter was a contributor, but it was really a more modest contributor. The bigger driver in the swing on volume was shipments behind new items that we’re launching. In particular, a range of those sauce items that have gone out, the larger sizes, for example, and some of the others. The other driver on volume has been just the strength of the Buffalo Wild Wings proposition as we’ve been able to bring online incremental capacity as we’ve had some of the viral marketing that’s taken place. As we look forward in Q4, I think it’s important for you and for the others to continue to track. We did have that $25 million pull forward last year. $10 million of that was in retail, $15 million of that was in Foodservice. Importantly, as we think about what the volume outlook might be like for the consolidated business, we continue to see a pathway to modest overall volume growth for the business in Q4. If you then look a little tighter at the retail business, we see line of sight there possibly to mid-single-digit organic volume growth. So we continue to feel good about it.

Todd Brooks, Analyst (The Benchmark Company)

That’s really helpful. Thanks. I’ll jump back in queue.

Operator, Operator

Thank you. Operator provided instructions. And it comes from the line of Andrew Wolf with C.L. King. Please proceed.

Andrew Wolf, Analyst (C.L. King)

Hi, thanks and also good morning.

Dave Ciesinski, President and Chief Executive Officer

Good morning.

Andrew Wolf, Analyst (C.L. King)

Kind of the state of trade relations—kind of an open-ended question a bit. The retailers, most of the supermarket chains or certainly the sector are having negative volumes; it’s not horrible elasticities, but it seems like all this pricing has caught up to the trade a bit. Some brands are losing share to private label, some of yours were, now they are not. What is this data play overall with price increases into saying, hey, we need another round of increases to retailer X, Y and Z? And second, what is the state of play with them asking for ramped-up promotions? I see you talked about your customer side, which goes through G&A, but more of the net sales one, which goes into the retail trade. Are they asking for more of that as well?

Dave Ciesinski, President and Chief Executive Officer

Andrew, I’ll start with retail. I would characterize conversations with our retailers as continuing to be very constructive. The last thing we want to do is go in and talk just about pricing to our customers. Because of the rate of inflation over the last couple of years, we’ve had many conversations about pricing. We’ve been able to counter those conversations by talking about new item launches and other initiatives to drive outsized growth. As I think about our relationships with retailers, I put them in a very constructive category because we’re discussing not just pricing, but volumetric growth and category growth ideas. We have had some tough conversations on pricing, and we continue to price through the first half of the year. We haven’t taken any pricing since the last time we spoke. Our retail business remains under pressure. When we go back into the marketplace and talk about pricing, we fully expect those conversations to be tougher than they were over the last 18 months. Regarding trade rates and promotions, to date we have not been receiving significant pressure to increase our trade rate on our items. I would expect those conversations to be most intense in commodity categories that have seen more aggressive declines or in areas where private label is more developed and the retailer feels more leverage. That is not our current circumstance. Retailers always want to talk about how we can drive category growth and the growth of their baskets. That is the lever we are working hardest to drive. Regarding below-the-line marketing spend, our investments tend to be focused on partnering with retailers to grow basket spending rather than exclusively on broad equity advertising. End to end, we’re working with retailers on innovation and marketing to grow their business, and those relationships continue to be collaborative. On the foodservice side, we have a transparent relationship with our foodservice operators, particularly national accounts, around commodity spend. We work with them to take positions on core commodities, and they tell us when they want to take a position and how far they want to go.

Andrew Wolf, Analyst (C.L. King)

Thank you. Quick follow-up just on the foodservice side—you’ve been rationalizing some items or contracts that were low margin. I think you said it was about a 4% volume impact. When does that cycle through?

Dave Ciesinski, President and Chief Executive Officer

We are really cycling through the end of that. You’ll see a little bit of an impact in Q4 and then it will have essentially run its course. The foodservice team, beyond rationalizing customers, has done a tremendous job of rationalizing SKUs, and that’s been an important contributor to improving margins overall. They deserve a lot of credit in that space.

Andrew Wolf, Analyst (C.L. King)

Great. Thank you.

Operator, Operator

Thank you. Operator provided instructions. And it comes from the line of Connor Rattigan with Consumer Edge. Please proceed.

Connor Rattigan, Analyst (Consumer Edge)

Hey, guys. Good morning. Thanks for the question.

Dave Ciesinski, President and Chief Executive Officer

Hi, Connor.

Tom Pigott, Chief Financial Officer

Hi, Connor.

Connor Rattigan, Analyst (Consumer Edge)

So obviously, a really strong top line this quarter, congrats guys. I was just wondering if you could help us understand the drivers a little better. The license portfolio was crucial, but how much of that 6% retail volume growth was due to comping a big launch quarter? Also on the foodservice side, is the increased demand that you called out incremental placements or higher consumption at existing locations?

Dave Ciesinski, President and Chief Executive Officer

The Arby’s contribution was a little less than 20% to that, so it was a notable contributor and we continue to be excited about how that proposition is performing. Buffalo Wild Wings was a strong contributor. To play was a strong contributor as well. Our own brand, New York Texas Toast, was also a strong contributor. The supply chain team has done a nice job of wringing out incremental capacity and our selling and marketing organization has done a nice job of selling that. Overall, the brand continues to be a strong story—on a one- or two-year stack it’s up between 20% and almost 25% on the sales line, and we are seeing that behind volume growth as well.

Connor Rattigan, Analyst (Consumer Edge)

That’s great. Thanks. And on the cost side as well, I know you’ve been trending at around 20% inflation for a while. Do you have a Q3 inflation figure you can share? And around the commentary about pricing and cost savings in place, are we expecting year-over-year margin expansion despite the inflation in Q4?

Tom Pigott, Chief Financial Officer

The Q3 inflationary impact was about 20%. It does begin to moderate a bit in Q4. When we look at the natural dilution from higher prices and higher commodities, we are looking at more of a 150 basis point impact year-over-year. But then as you look at the offsets, we get contributions from cost savings initiatives and value engineering. We’ve talked about improved sales mix and the discontinuations Dave mentioned, and insourcing. All of that will help us mitigate the natural dilution in Q4. So we are looking at kind of a consistent gross margin percentage versus the prior year in the fourth quarter.

Dave Ciesinski, President and Chief Executive Officer

Beyond that, it is moderating. We are seeing oil moderate and some other categories moderate like eggs, particularly more recently, but those are being offset by other categories that continue to run, particularly sweeteners. We will have more to share when we report Q4 results.

Connor Rattigan, Analyst (Consumer Edge)

Okay. Perfect guys. One more quick one—on the rollout, it looks like tracks similar to Chick-fil-A. How happy are you with the rollout to date? Is it in line with expectations or running ahead?

Dave Ciesinski, President and Chief Executive Officer

I would say it’s in line with our expectations. With retail launches, it takes time for our retail partners to get items cut into the shelf, get the right number of facings and for consumers to become aware and trial. For items like Arby’s, retailers initially place them where they can, often lower on the shelf; as the item turns, it migrates closer to the bull’s eye and facings increase. We saw that pattern with Olive Garden and other launches. We are seeing the same play out with Arby’s. It’s running in line with what we thought, and we’re pleased Arby’s partnered with us. Our team has executed well in retail.

Connor Rattigan, Analyst (Consumer Edge)

Alright. Thanks for the color, guys. Appreciate it.

Operator, Operator

Operator provided instructions. We have a follow-up from the line of Andrew Wolf from C.L. King. Please proceed.

Andrew Wolf, Analyst (C.L. King)

Hi. From a strategic question, with the third wave of the ERP implementation behind you, you have handled different phases from beginning to getting things up and running and working with consultants to doing it yourself. It seems you have addressed many contingencies. I want to link this to potential M&A since getting a good ERP system into a decent-sized target would be important for realizing synergies. Where are you at with the ERP implementation such that you would have enough confidence to say we can take a target and do all we need to do with integration based on how the ERP implementation has gone?

Dave Ciesinski, President and Chief Executive Officer

As we pointed out, we have completed Wave 1, Wave 2 and Wave 3, so we have taken the financial backbone, the GL, and other core elements onto the new system. We have been rolling in plants and warehouses, with our flagship factory in Horse Cave comprising much of Wave 3. Wave 4 remains and we expect to drive that in the current quarter, bringing the last of our dressing factories online and two dressing warehouses. None of that will be new art in Wave 4; it’s about ensuring we have enough people in place to perform hybrid care as we change the way people work, so we can service the business. We fully expect between now and when we report Q4 results in August that Wave 4 will be behind us and we’ll move into a stabilization, utilization and training period—bedding down the system, cleaning up remnants and helping our plant teams become more efficient. That also creates a window for M&A. SAP has enabled us to better integrate acquired businesses. From a timing perspective, once Wave 4 and the stabilization period are complete, we’ll be in a stronger position to evaluate both smaller and larger acquisitions and integrate them effectively. The last three years involved externally imposed change from COVID and supply chain disruptions; the ERP transformation has been internally imposed change. That period is winding down, and we’re excited to focus on improving performance and pursuing strategic opportunities.

Andrew Wolf, Analyst (C.L. King)

On the training and utilization part that you will be entering into fiscal 2024, ERP benefits are often cumulative—crawl, walk, run—and potentially exponential if it goes well. Do you feel you need to have some legs behind that before you pursue an acquisition to see payoff from the system, or can you implement and realize payoff simultaneously while bringing in new business?

Dave Ciesinski, President and Chief Executive Officer

We think about the total weight on the branch for the organization. Over this year we’ve had significant weight from the ERP implementation and from doubling square footage of our flagship factory. Those weights are starting to diminish. I wouldn’t say we need the system to be fully 'infected' before entertaining an acquisition, but we do need to look at the overall cadence of the business and feel there is sufficient capacity to take on an acquisition without disrupting service to strategic retail and foodservice customers. In short, we don’t need every benefit realized before considering targets, but we need confidence that we can integrate and service our customers seamlessly.

Andrew Wolf, Analyst (C.L. King)

Thank you.

Operator, Operator

Operator provided instructions. I am not showing any further questions. I will turn the call back to Mr. Ciesinski for his concluding comments.

Dave Ciesinski, President and Chief Executive Officer

Thank you, operator and thank you everyone for your participation this morning. We look forward to sharing with you our fourth quarter results when we are back together in August. Have a great day.

Operator, Operator

Thank you again for participating and you may now disconnect.