Earnings Call Transcript - MZTI Q4 2020

Megan, Operator / Conference Call Facilitator

Good morning. My name is Megan and I will be your conference call facilitator today. At this time, I would like to welcome everyone to the Lancaster Colony Corporation, Fiscal Year 2020 Fourth 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. Thank you. And now to begin the conference call, here is Dale Ganobsik, Vice President of Investor Relations and Treasurer for Lancaster Colony Corporation.

Dale Ganobsik, Vice President of Investor Relations & Treasurer

Thank you, Megan. Good morning everyone and thank you for joining us today for Lancaster Colony's fiscal year 2020 fourth 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 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 fiscal ‘21. At the conclusion of our prepared remarks, we’ll be happy to respond to any questions you may have. 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 & CEO

Thanks Dale and good morning everyone. It's a pleasure to be here with you today as we review our fourth quarter results for fiscal year 2020. I'd like to begin by extending a sincere thank you to the entire Lancaster Colony team for their tremendous efforts during the past five months, as we confronted the impact of the COVID-19 pandemic. From the front line workers at our plants and distribution centers, to all the associates and leaders throughout our business, I am extremely proud of how we pulled together and worked in common cause to meet the shifting demands of our business. From the onset of the coronavirus 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. Despite all the uncertainty and obstacles that COVID-19 has imposed on our business, we completed fiscal year 2020 with record net sales of over $1.3 billion and record gross profit of $358 million. In our fiscal fourth quarter, excluding Omni Baking sales, consolidated net sales grew 70 basis points. Net sales in our retail segment grew 24.5%, while our food service segment reported net sales declined 24.1%. Retail net sales benefited from higher demand as the impacts of COVID-19 drove increased at-home food consumption. We were pleased to see that our recent new product introductions contributed about 4.5 percentage points to our retail segment's Q4 sales growth. Notable contributors to growth included our single bottle offering of Buffalo Wild Wings sauces and, separately, Chick-fil-A sauces that we are selling in a regional pilot test in Florida. Both the Buffalo Wild Wings and Chick-fil-A sauces are being sold under exclusive license agreements. Following a strong third quarter, retail sales trends remained robust in the fourth quarter for our New York bakery frozen garlic bread, Sister Schubert's frozen dinner rolls and Olive Garden dressings. In our food service segment, excluding all Omni Baking sales, fourth quarter net sales declined 22.2%. The food service segment was adversely impacted by COVID-19, particularly in the month of April, but recovered notably in May and June led by the quick service restaurant customers within our national account base. Despite the unfavorable influences of COVID-19, we grew our fourth quarter consolidated gross profit by $10.9 million or 13.9% to a fourth quarter record $89.1 million. The gross profit improvement was driven by the favorable sales mix, our cost savings programs and improved net price realization in retail. Notable offsets to gross profit attributed to COVID-19 included much deserved wage rate increases for our frontline employees, and in keeping with our top priority, investments to promote safe operations at all of our facilities. I'll now turn the call over to Tom Pigott, our CFO for his commentary on our Q4 financial results.

Tom Pigott, Chief Financial Officer

Thanks Dave. Overall the quarter's results exceeded our expectations. After a challenging April the business recovered strongly. The performance is reflective of the many actions taken by employees to address the impacts of the COVID-19 outbreak and the focus they maintained on our key objectives. Fourth quarter consolidated net sales decreased 90 basis points to $320.9 million. Excluding Omni Baking sales of $2.8 million in the current year quarter, and $7.7 million in the prior year quarter, consolidated net sales increased by 70 basis points. As you recall, Omni Baking sales are attributed to a temporary supply agreement. These sales will continue to decline as a supply agreement comes to an end during our fiscal second quarter. Consolidated gross profit increased $10.9 million or 13.9% to $89.1 million, and gross margins grew by 360 basis points. The increase was driven by the strong revenue growth in the retail segment, our cost savings programs, improved net price realization in retail and lower commodity costs. These favorable impacts were partially offset by the COVID-19 related items, including nearly $3 million in incremental frontline worker pay, as well as other costs, ensuring the safe operation of our facilities. Selling, general and administrative expenses increased $8.9 million or 22%. There were two main drivers behind the increase. First, was the investment we're making in our ERP program entitled Project Ascent, which accounted for $3.8 million of the increase. The second main driver was a $3.2 million write-off of previously capitalized engineering costs related to our decision to cancel the Horse Cave expansion project. As we discussed in our Q3 call, we elected to cancel this project and reassess our longer term capacity needs given the rapid change in demand we are seeing. Note that an expansion project with a different design remains a strong possibility for the future, and we'll have more to share on these plans in an upcoming call. Consolidated operating income declined $3.1 million versus the prior year to $40.2 million. It’s important to note that the prior results included a $7.4 million favorable adjustment to contingent consideration and the current year results include the incremental $3.8 million in ERP expenses and the COVID-19 items mentioned above. Key drivers of the strong operating income growth excluding these items include the top line performance, favorable mix and cost savings programs. Our effective tax rate was 24.6% this quarter versus the tax rate of 25.4% in the fourth quarter of fiscal 2019. We estimate our tax rate for fiscal ‘21 to be 24%. Fourth quarter diluted earnings per share decreased $0.10 to $1.10. Increased expenditures for Project Ascent accounted for the $0.10 of the decline. The prior year fourth quarter benefitted from the change in contingent consideration, which totaled $0.21 per share. With regards to capital expenditures, our fiscal ‘20 payment for property additions totaled $82.6 million. Our investment in fiscal ‘20 included expenditures for our frozen dinner roll capacity expansion project and the purchase of the Omni-Baking facility that was previously leased. Looking forward to fiscal year ’21, we are forecasting total capital expenditures between $65 million and $85 million based on plans currently in place. We are in the process of evaluating additional and potentially significant investments to meet the rapid growth in demand for our products. These projects will be added to this forecast. We’ll provide you with future updates on our plans once they are more fully developed. In addition to investing in the business, we also returned funds to shareholders. Our quarterly cash dividend paid on June 30 was $0.70 per share, an 8% increase from the prior year amount. Our longstanding streak of annual dividend increases reached 57 years this past December. Despite the higher level investment and increased dividend payments, our financial position remains very strong as we finished the quarter debt free with $198 million of cash on the balance sheet. So to wrap up my commentary, this quarter featured strong underlying performance, highlighted by increased consumer demand for our retail products and improving sales trends in our food service segment. The business continues to monitor and adjust to the impacts of the COVID-19 outbreak, while investing for longer term growth. I will now turn it back over to Dave for his closing remarks. Thank you.

Dave Ciesinski, President & CEO

Thanks Tom. As we look ahead to fiscal year 2021, sales for both our retail and food service segments will remain subject to the shifts in demand resulting from COVID-19. The extent and duration of the pandemic related impacts are unpredictable and contingent upon the future spread of the virus and the resulting effects on consumer behavior. That said, we anticipate continued top line growth in the retail segment from shelf-stable dressings and sauces sold under license agreements, most notably Chick-fil-A sauces, Buffalo Wild Wings sauces and Olive Garden dressings. In food service, the heavier mix of our business towards quick service restaurant, which represents over 60% of food service segment's total sales will remain a positive in the current environment. On the commodities front, we're projecting a moderate rise in the coming year following a favorable year in fiscal 2020. We expect that our cost savings programs and favorable net price realization will help offset commodity cost inflation. With respect to our ERP initiative, Project Ascent, we recently completed the design and build phase as planned and are now into the test phase. We expect to finish the test phase near the end of fiscal 2021 followed by the deployment phase. Strategically, as we look ahead to fiscal 2021, we 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 plans. Number one, to accelerate our base business growth; number two, to simplify our supply chain, to reduce our cost and grow our margins; and number three, to identify and execute complementary M&A to grow our core. Before opening up the call to questions, I'd like to take a few moments now to share with you some information regarding discrete actions that we, in keeping with our vision to be the better food company, have underway here at Lancaster Colony to do our part to eradicate racism and commit to diversity, inclusion and belonging, both in the workplace and in the communities where we operate. First, we established a new position within the organization, Vice President of Corporate Affairs and Government Relations to provide leadership in developing and executing plans to drive our company's engagement in state and local government, corporate citizenship, social responsibility and sustainability initiatives. I'm pleased to announce the hiring of Clarence Mingo to this position effective August 17. Clarence’s role will also include oversight of our diversity and inclusion programs. Second, I'm happy to share that Lancaster Colony has formally adopted a diversity hiring statement, otherwise known as the Rooney Rule, which reinforces our commitment to including highly qualified women and minority candidates, as well as highly qualified candidates with diverse backgrounds, skills and experiences in the pool of candidates we consider for new leadership positions. Third, I'm excited to announce that we've entered into a partnership with Cristo Rey High School here in Columbus Ohio. Cristo Rey provides a work-study model of education for students from low income families, whereby corporate partners provide tuition support and work-study mentorship for their students. Cristo Rey High School was established in 2013, and it's been fostering the growth of students and sponsors alike since its inception. Finally, in support of our team members here at Lancaster Colony, we will be establishing an Employee Relief Fund. The purpose of this program will be to assist our employees that encounter tragic life events that result in financial hardship. While the company plans to make an annual contribution to this fund, our employees will also have the opportunity to support the fund through their personal donations. In closing, I would again like to thank the entire team here at Lancaster Colony for all they have done to help make fiscal 2020 a success, despite all of the unprecedented challenges. I would also like to thank our shareholders and other stakeholders, including our customers and suppliers for their ongoing support. We look forward to partnering with them to pursue the opportunities that lie ahead in fiscal 2021 and beyond. This concludes our prepared remarks for the day and we'd be happy to answer any questions you might have.

Megan, Operator / Conference Call Facilitator

Our first question is from Brian Holland with D.A. Davidson and Company. Your line is open.

Brian Holland, Analyst, D.A. Davidson & Company

Thanks. Good morning and congratulations!

Dave Ciesinski, President & CEO

Good morning Brian.

Tom Pigott, Chief Financial Officer

Hey Brian! Good morning.

Brian Holland, Analyst, D.A. Davidson & Company

So, quickly on food service to start, down 24% in 4Q. Can you provide some context around how those trends progressed for the quarter? Maybe where that segment is sort of trending today?

Dave Ciesinski, President & CEO

That's a great question. If you look at April, across all away-from-home dining, April was a very tough month. If you look across all segments—QSR, midscale and casual dining—it was probably down around 40%. As May and June progressed, it improved notably. Coming out of June we were looking at transaction volumes from MPD Crust that were down somewhere in the order of 12%. As we continued through the remainder of June and into July and early August, what we're seeing now is transaction volume from MPD Crust running probably down around 10%. If you layer onto that, that's transaction; it doesn't include the size of the check. What we're looking at is sales are slightly better than that and there are some customers, notably Pizza QSR, Chick-fil-A and a handful of others that are actually posting positive comps and in some cases record sales. So it started very low in April and then rebounded nicely thereafter. But we're still pacing on the transaction level down in the high single digits.

Brian Holland, Analyst, D.A. Davidson & Company

Okay, so down high single digit dollars, maybe slightly better than that. When I think about your business, one of the key things that has been clear is you have more favorable exposure given the QSR mix and notably the national chains. So fair to assume that you're trending maybe even a little bit better than what you were just referring to from an industry level?

Dave Ciesinski, President & CEO

Maybe ever so slightly better than that. The stats I gave also reflect that QSRs have outsized development within food service at large and our regional food gets a lot of that benefit.

Brian Holland, Analyst, D.A. Davidson & Company

Okay, perfect. On the retail side, I think you mentioned 4.5% contribution from new products. I just want to be clear, because you have a myriad of new products and channel expansion initiatives. Does that comment refer specifically to the licensed products, most notably Buffalo Wild Wings and Chick-fil-A, or are there other contributors to that mix that you're referencing?

Dave Ciesinski, President & CEO

It's the ones you mentioned—Buffalo Wild Wings and Chick-fil-A sauces—and then smaller contributions from an item we launched called Bibibop and some of our own items like Tastefully Dressed. To provide broader context on retail: over the same period that food service backed off in April, retail saw a spike. Multi-outlet data for all food indicates food running about plus 10% to 11%, and given the categories we play in, we are performing better than that. As we look forward, one of the big questions is when and how the industry begins to revert toward more traditional norms, i.e., retail moderates and food service picks up. We expect the strength of our new items—particularly Chick-fil-A sauces, Buffalo Wild Wings and continued organic growth of Olive Garden—will continue to give us a nice tailwind over the next year.

Brian Holland, Analyst, D.A. Davidson & Company

Okay, I appreciate that. Last one from me and then I’ll hop back in the queue. There’s a lot of conversation in the market around Chick-fil-A and Buffalo Wild Wings in particular. Olive Garden has been a roughly $100 million brand over about eight years and folks are wondering about the pace at which you can replicate that. As you talk to both of these brands, do they have potential to be as big or bigger than Olive Garden and what drives the pace compared to Olive Garden?

Dave Ciesinski, President & CEO

Absolutely. Everything we've seen in our fiscal fourth quarter and in the first quarter continues to affirm our belief that both Chick-fil-A and Buffalo Wild Wings have the potential to be at least as big, and quite possibly bigger than Olive Garden, with likely faster timing. We've been in the Olive Garden space about seven years. It started in club, moved into retail, expanded through retail and now into dollar and drug channels. Now that we understand the opportunity more completely, we're going to try to capitalize on that growth more quickly. Also, food service operators are seeing the power of their brands in retail and our retail partners are seeing the strength and relevance of these brands and how they move off the shelf. If you look at velocity on those items, they are considerably higher than other items in the category, which gives us a lot of optimism about the potential if we can execute.

Brian Holland, Analyst, D.A. Davidson & Company

Thanks. I appreciate it. Best of luck.

Tom Pigott, Chief Financial Officer

Thanks Brian.

Megan, Operator / Conference Call Facilitator

Your next question is from Ryan Bell from Consumer Edge Research. Your line is open.

Ryan Bell, Analyst, Consumer Edge Research

Good morning, everyone.

Dave Ciesinski, President & CEO

Good morning, Ryan.

Tom Pigott, Chief Financial Officer

Good morning, Ryan.

Ryan Bell, Analyst, Consumer Edge Research

I appreciate that there are a lot of moving parts right now, but could you speak a bit more about your fiscal 2021 outlook? What your expectations would be for the retail business, the cadence of the food service recovery and then could you highlight in a little bit more detail some of the negative commodity pressures that you're expecting?

Dave Ciesinski, President & CEO

I'll start with the top line. In keeping with our tradition, we don't provide guidance, but anecdotally we see multi-outlet food running around plus 10%, and we've been running stronger than that. As long as the COVID outlook remains where it is with people eating more at home, we expect the trends we've seen to continue. The big unknown is timing of therapeutic or vaccine and how quickly people return to workplace and eating out. As retail moderates, the strength of new items—especially Chick-fil-A sauces, Buffalo Wild Wings and Olive Garden—will provide a tailwind for top line growth in retail. Tom can speak more on commodities.

Tom Pigott, Chief Financial Officer

On margin outlook: Q4 benefited from the mix shift to retail, which was a key driver of margin growth. Going into fiscal '21, a lot depends on how long retail growth continues. We feel really good about the new product pipeline and efforts to convert new users to repeat users. In terms of headwinds, we expect commodities to be more inflationary. We see it in oil and a little bit in sweeteners, based on some of the hedging positions we took previously where we did not experience the same cost impacts others did last fiscal year. As that coverage wears off, we expect higher costs. That said, cost savings programs and revenue management initiatives should help offset commodity cost inflation. We also expect some higher COVID-related expenses continuing into this fiscal year.

Ryan Bell, Analyst, Consumer Edge Research

Thanks for the color. Maybe drilling more into the food service business: we've seen better recovery of QSRs and you seem exposed heavily to QSRs. Can you talk about the percentage of your sales in the food service business that come from QSRs and maybe what the margin differences might be between the QSR parts of your business and the other parts that might be recovering slower?

Dave Ciesinski, President & CEO

If you look at our food service segment, which coming into this period was roughly half of the business, about 60% of that is in QSR, which includes traditional QSR as well as Pizza QSR, and most of those concepts are performing quite well—some posting record numbers. About 15% of food service is other national accounts, including mid-scale and casual dining; casual dining is rebounding nicely as well. There's a smaller portion—probably around 20%—that we would categorize as branded, which tends to include schools, universities and non-commercial channels; that's the part that has not really recovered and is still off double digits, probably in the 20% range. The last piece is industrial where we sell products to other food manufacturers and that's remained robust. So roughly 80% to 85% of our food service business is doing well; about 15% is not, but demand is somewhat fungible and some of it is moving back into chains.

Ryan Bell, Analyst, Consumer Edge Research

Thanks, that's very helpful. That’s it from me.

Tom Pigott, Chief Financial Officer

Thank you.

Megan, Operator / Conference Call Facilitator

Your next question is from Todd Brooks with C.L. King & Associates. Your line is open.

Todd Brooks, Analyst, C.L. King & Associates

Hey, good morning guys. Congratulations on the quarter.

Dave Ciesinski, President & CEO

Thank you, Todd.

Todd Brooks, Analyst, C.L. King & Associates

First, can you talk about gross margin performance in the quarter, which was well above expectations. I know there’s a mix element with retail versus food service, but you expected some friction in the quarter as you balanced production between rising retail and temporarily impaired food service. What's the right way to think about Lancaster's gross margin potential in fiscal '21 as that friction normalizes, and you continue delivering cost savings?

Tom Pigott, Chief Financial Officer

Excellent question. We discussed unabsorbed overheads in Q3 and in April we felt outsized demand reductions in food service. As the food service business recovered and retail growth remained strong, that friction went away toward the end of the quarter. We don't see unabsorbed overheads being an item going into the next fiscal year. Key items going into fiscal '21 are how retail growth continues, since the margin differential between retail and food service is a key driver, and continued cost savings initiatives. Commodities are more inflationary, but we're focused on offsetting that with revenue management. Overall, we feel very good about our margin prospects driven by retail revenue growth and the new items mentioned.

Todd Brooks, Analyst, C.L. King & Associates

That's great. Secondly on the retail category broadly, you talked about restaurant partners wanting to develop alternate revenue streams and retailers wanting these products. Can you talk about your pipeline from a development standpoint? Are you seeing existing foodservice partners coming to you to build retail offerings or outside customers recognizing Lancaster's expertise and reaching out?

Dave Ciesinski, President & CEO

Short answer: yes to both. New concepts have reached out in the last quarter to express interest. Among the brands we partner with, we can grow laterally into other channels and vertically by introducing new flavors. Buffalo Wild Wings and Chick-fil-A sauces have a range of flavors that allow us to move into different occasions. Credit goes to the Darden team that saw this opportunity early and partnered with us to ensure it wouldn't cannibalize restaurant business. It played out well and other operators have more confidence to play in the space.

Todd Brooks, Analyst, C.L. King & Associates

Okay, great. Two more quick ones: on Project Ascent you mentioned moving into the testing phase. Any color on what the cost during this phase for fiscal '21 should look like for ERP?

Dave Ciesinski, President & CEO

First, credit goes to the team and our integration partners for completing design and build remotely during the pandemic. We completed design and build and are now in testing. You can expect us to take a couple of small pieces of the business that aren’t related to core operations live during the fiscal year as tests. Our plan is a full go-live on order to cash shortly after the beginning of the next fiscal year. The team deserves credit for figuring out how to do this remotely; they're doing that same thing in testing now.

Tom Pigott, Chief Financial Officer

In Q4 the gross spend was a little over $9 million. A portion of that was capitalized and $5.5 million hit the P&L. Going into the next fiscal year, what we'll capitalize is the design of the system and with the design work completed, we won't be capitalizing as much. The spend will go up slightly, so you'll see a slightly higher P&L charge going into the next fiscal year on ERP as we've completed the design phase and are moving toward implementation.

Todd Brooks, Analyst, C.L. King & Associates

Okay, great. And final question: expectations for fiscal '21 and '22 around Chick-fil-A sauces. You had a successful pilot in Florida. Can you talk about regional rollouts, national timing and how this compares to Olive Garden in terms of pace?

Dave Ciesinski, President & CEO

Next month we're beginning a national rollout of a catering bottle that will be in Chick-fil-A restaurants to convert their take-away and catering business to bottles. Towards the end of October we will begin the first retail rollouts in regions in the Southeast, and about eight weeks later take a bigger swath of the Southeast with our retail partners. After the beginning of the calendar year, we'll take it across another swath of the United States, so that by the end of the fiscal year we'll have it in full national distribution across all of retail. It's a relatively fast ramp given what we’re doing. Comparing to Olive Garden, we weren't in retail for the first two to three years; we expect to go after the bigger retail opportunity considerably faster and then look at club and other points of distribution thereafter.

Todd Brooks, Analyst, C.L. King & Associates

Okay, great. Thanks for the color and congratulations again.

Dave Ciesinski, President & CEO

Thank you.

Megan, Operator / Conference Call Facilitator

If there are no further questions, we will now turn the call back to Mr. Ciesinski for closing comments.

Dave Ciesinski, President & CEO

Thank you, Megan, and thank you everyone for participating this morning. We look forward to sharing our first quarter results with you in early November.

Megan, Operator / Conference Call Facilitator

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