Lancaster Colony Corporation

Good morning. My name is Cheryl, 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 2022 First Quarter Conference Call. Conducting today's call will be Dave Sisinski, President and CEO, and Dave Pica, CFO. All lines have been placed on mute to prevent any background noise. After the speakers have completed their prepared remarks, there will be a question and answer period. If you would like to ask a question during this time, then please press star, then the number one on your telephone keypad, and questions will be taken in the order that they are received. If you would like to withdraw your question, press star one again. Thank you. And now to begin the conference call, here is Dave Gnabczyk, Vice President of Corporate Finance and Investor Relations for Lancaster Colony Corporation.

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 and 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 Sosinski, our president and CEO, will begin with a business update on highlights for the quarter. Tom Biggett, 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 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 Sosinski. 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 30th, 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 food service 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 comes 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 Wing Sauces. The sales for those two product lines combined to 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 26th showed total U.S. food sales of Chick-fil-A sauces at $35.1 million and sales of Buffalo Wild Wings sauces at $13 million. Olive Garden Dressings remains 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 their category share to 6.3% during the quarter. With respect to our own brands, per IRI data for the 13-week period ending September 26th, highlights included a 450 basis point pickup in market share for our own New York bakery in the frozen garlic bread category. In our food service segment, excluding OmniBaking 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 food service products. Excluding inflationary pricing, sales volumes to our national chain restaurant customers were similar to last year. Food service operators industry-wide are facing the challenges of a tight labor market, product supply issues, and rising costs. NPD crest data for U.S. food service industry shows that weekly transactions for the quarter ending September 30th 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 Piggott, 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 food service segment and favorable revenue mix. Consolidated gross profit decreased by $300,000 to $92.4 million. Gross profit benefited from the volume in 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 points 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 food service pricing lagged the commodity increase during the quarter. Beyond the significant commodity inflation, we incurred higher co-manufacturing costs 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 21. We estimate the tax rate for fiscal 22 to be 24%. First quarter diluted earnings per share decreased 24 cents 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 13 cents a share. In addition, costs related to Project Ascent reduced this quarter's EPS growth by 3 cents 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 22, we are forecasting total capital expenditures between $170 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 return funds to shareholders. Our quarterly cash dividend of 75 cents per share, paid on September 30th, 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 are making and the increased dividend payments, our financial position remains very strong as we finish 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 cost 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 food service segment should continue to benefit from higher demand for our food service products and grow 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 food service 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 food service channels, industry-wide supply chain challenges and inefficiencies, and higher costs to produce our products and service to our customers. Moving on to our supply chain strategy, our significant investment in production capacity at our dressing and sauce facility in Horse Cape, 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 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 result 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?

At this time, I would like to remind everyone, in order to ask a question, please press star 1 on your telephone keypad. 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, we're continuing to see strength driven by the Chick-fil-A partnership. It appears there's room for that to continue growing throughout fiscal 2022. How are you thinking about the growth prospects as you lap the national launch last year, you know, and specifically, you know, the months where it had been nationally distributed already?

Yeah, absolutely. Ryan, if you go back and you look at the scanner data sales, Q4 of last year, The last fiscal year, I think, was about 38 million. Q1 of this quarter, scanner data was about 35. And 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 push because as you're well aware right now, we're constrained. And this is just on Chick-fil-A sauce I'm talking about here. we're constrained on capacity. As you look at more broadly across the algorithm in retail, we expect to see continued growth, sequential growth throughout the year. Now, let's kind of take a step back and talk about Chick-fil-A. As we think about it, as we finish this fiscal year and we continue this growth, There are several things that are going to start to open up as we get into the next fiscal year. The first of which is we're bringing online incremental bottling capacity that's going to allow us to take the product off allocation with our customers and allow them to begin to merchandise the item in ways that you would other items in a grocery store. The other thing that that's going to allow us to do is to bring to the market new flavors and new sizes. And these are discussions that are actively underway with our partner at Chick-fil-A. And we're going to be excited to share more news about that with you in the forthcoming quarter. So, you know, we're excited to see how this product is performing. We continue to see strong results in terms of trial and repeat. And, you know, We just think that there's a ton of upside on this brand proposition.

Thanks. That's helpful. And then it seems largely the biggest thing, at least for the Chick-fil-A partnership, that's holding you back is just capacity. And then as we're thinking about potentially other opportunities within our food service partnerships at retail, how would you think about that playing out?

Oh, it's another great question. So as we look at it, the way we're looking at this in general is almost, Brian, like the way you would look at other inorganic growth. You know, at our company, like others, we're constantly looking at acquisition opportunities, and we think of them in terms of a pipeline. We take that exact same approach, though, and we apply it to the way we think about licensing, right? With the first and closest-in opportunities being expanding with existing partners and And then looking at new partners. And there again, when we bring that capacity online, it's going to give us the opportunity to bring online new partners in potentially some new categories. I'm not in a position to share that with you right now, but we have a number of great things that are underway and look forward to sharing more of that with you in due course.

Thanks. In terms of the project design costs, Could you provide any details regarding the expected magnitude of those costs over the coming quarters? And then just a little bit more detail, again, on your decision to shift the implementation out until 2023?

Yeah. So what I would tell you is, you know, next quarter is going to be on or about cost proximate to 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 then go live in Q4, and then you can expect to see those costs start to wind down into fiscal year 2023. is sort of the way that they're cadenced out. And the reason why they're essentially going to be flat for the first quarter and this quarter is because at this point we're into testing. As we cross over into the next calendar year, R2, 3, and Q4, really we're going to be going through very intensive training and getting employees ready to go to take this product live. And these aren't expenses that you can capitalize. You run them through the P&L, and it's the final push. As you think about what we're doing, that first wave that we're bringing live is the back office of the business. It's order to cash. It's procure to pay. It involves trade spending. We're also bringing online our frozen DCs and just a couple of factories. In the subsequent waves, what will happen is, is that the scope of the implementation will start to wind down. And we're going to be essentially stamping out factories several at a time until we're completed with this project, which will wind its way down through the end of 2023, per the timing. Now, there's a second question, which is, why did we elect... to defer the project to make it line up with the fiscal year. And there are a couple of reasons for that, Ryan. The first is we stepped back and we said, what are truly the priorities of our business? And first and foremost, it's servicing our key strategic customers. Namely, our food service customers, be it Darden Restaurants and Olive Garden and their other elements, Chick-fil-A, Buffalo Wild Wings, and others. In many cases, we're a sole supplier to those guys and their menu for their items. And for us to put them in a situation where we're not able to deliver not only impacts our business, but it could severely impact their business. And given all the external complexities that we were seeing when we went through a planning process, we elected that it would be safer to push it out a little bit farther to ensure that we are in a position to build up inventory and to execute it safely. So parenthetically, if you go through and you get a chance and you look at the queues, you're going to see some movement in our inventory. Part of that is driven by a reval because of inflation, but part of that is driven by the fact that we are carrying more inventory as a buffer to make sure that we can service our business now and in preparation for servicing our business when we prepare to go live. So really, that decision, more than anything else, was just driven by the fact that we want to make sure that we nail the implementation for our company and our shareholders, but we also nail it for those strategic partners.

Thanks. And where in your business are you seeing the largest inflationary pressures? And as we're thinking about gross margins throughout the balance of the year, I know you don't provide guidance, but any color on the moving pieces would be helpful. And then maybe some of the impacts as we're seeing food service coming back, retail still growing strongly, but at some point that's going to fade out. Just some of the implications that you'd see in terms of gross margins coming from the balance of those moving pieces.

Thanks, Ryan. Yeah, this is Tom. So overall, we did see commodity inflation in the quarter in the mid-teens. The most pronounced impact for us was in soybean oil, where the costs are close to double. That impacts both of our segments, but in this particular quarter, we saw more of an impact in the food service PNOC as our pricing lagged the commodities, and you can see that in the food service results we reported. Now, going forward, as we shared on the retail side, we'll get the full impact of the first round of pricing that will be reflected in Q2 fully, as well as a catch-up on food service pricing, which will improve our margins there as well versus the declines we reported this quarter. Now, in the future, you know, certainly we're modeling our PNOC and forecasting the commodities. We look at it very closely. We have a number of scenarios on the board. And over time, our goal and our belief is that we'll be able to offset these commodity impacts, be it through pricing, trade reductions, other revenue realization approaches.

Thanks. That's helpful. And then as we're looking at some of the food service trends, you know, we're continuing to see improvement. How much of it hasn't really recovered due to COVID yet? And then I know you touched on some of the NPD trends in your prepared remarks, but would you be able to go into a little bit more detail about some of the industry-level trends you're seeing in food service, and then maybe how you think about that in terms of the potential for sequential improvement continuing for the food service business?

Yeah, Ryan, I'll go ahead and take that one. You know, it's an interesting quarter. If you look at where the quarter began in July, what we saw was, and I'm going to talk about transaction data, right, is transactions were actually strong. They were running in the, you know, Low to mid-single digit, mid-single digit range for all the various outlets, you know, QSR on a consolidated basis. As we got towards the middle of August, all of a sudden we started to see transaction data start to pull back. And it actually started to go slightly negative, you know, let's call it 1%. And it sort of ran that way through the remainder of the quarter. Now, as you pull that apart, what you saw were there were some segments, like mid-scale, that continued to perform pretty darn well through the whole quarter. But bear in mind that those segments were lapping a horrible comp last year, where they would have been down 60% or 70%, right? But if you kind of go to where's the center of gravity of food service, which is around QSR and casual dining, but QSR principally, I think the story to watch is that as we started the quarter again, we were in the, let's call it the mid single digits positive, and then it flipped slightly negative. So by the time you looked at a 13-week data period in MPD, you're looking at transactions that are basically flat. What we believe is going on in this case is that operators are wrestling with labor. And as a consequence, they're curtailing their hours of operations, and in some cases, their days of operation. And that's translating into fewer transactions. If you look at the sales data, Given the fact that they're passing on inflation, it's masking that. But in terms of what we see in terms of the volume that runs through their boxes, we are seeing a modest pullback there. So as we look across the remainder of our fiscal year, what I would continue maybe to focus on is, fortunately, we are going to be lapping some softer comps. But to some degree, we're going to be beholden by how well they're able to staff and run their operations. I wouldn't expect to see a material pullback in hours and operations from where they are today. But every one of these guys out there are making triage decisions. In some cases, they're limiting menu items to reduce complexity in the restaurant. In other cases, they're limiting hours in order to manage complexity. And in the final case, some of them, in the case of QSR, are closing their dining rooms and focusing on their drive-through or take-out business. So we do see line of sight to continued growth given the soft comps. It's a business that we believe in. But their challenges are manifest and they're real.

Thanks, that's helpful. And then in terms of capital allocation priorities for fiscal 2022, would you be able to provide any details about that potentially, you know, on M&A or any additional capital expenditures to support some of the demand that you're seeing within the retail business?

Yeah, Ryan, that's an excellent question. So, you know, as we've shared this year, we'll be spending between $170 and $190 million heavy spend behind that horse cave expansion project. You know, today we're looking at a number of growth scenarios on the business. And as it relates to capital allocation, I think position one is supporting that growth. So we're looking at potential greenfield, brownfield expansions, as well as potential acquisitions of existing dressings and sauce businesses to support the robust growth. Then beyond that, We do think about M&A, but I think our focus in the short term is to take care of our existing demand, support the continued growth of the licensing platform with our capital allocation, and then implement the ERP system, and then potentially think about other alternatives to continue to support our growth.

I think that's it for me.

All right. Thank you, Ryan. Well, if there aren't any other questions, I want to thank each of you for joining this morning, and we look forward to getting together on the call when we share with you our second quarter updates. In the meantime, I hope you guys have a happy, safe, and productive fall.

This concludes today's conference call.