Lancaster Colony Q2 2024 Earnings Call Transcript

Quartr
Provided by Quartr
February 1, 2024

There are 10 speakers on the call.

Operator

Good morning. My name is Didi, 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 2024 Second Quarter Conference Call. Conducting today's call will be Dave Sysinski, President and CEO and Tom Pigott, will be a question and answer period. Thank you.

Operator

And now to begin the conference call, here is Dale Ganobsik, Vice President of Corporate Finance and Investor Relations for Lancaster Colony Corporation.

Speaker 1

Good morning, everyone, and thank you for joining us today for Lancaster Colony's fiscal year 2024 2nd quarter conference call. Our discussion this morning may include forward looking statements, which are subject to the Safe Harbor provisions of the Private Litigation Reform Act of 1995. These

Speaker 2

statements are subject to

Speaker 1

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, lancastercolady.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.

Speaker 1

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?

Speaker 2

Thanks, Dale, and good morning, everyone. It's a pleasure to be here with you today as we review our Q2 results for fiscal year 2024. In our fiscal Q2, which ended December 31, we are pleased to report record financial results As consolidated net sales increased 1.8 percent to $485,900,000 gross profit grew 19 percent to 121 point $5,000,000 and operating income increased 28.1 percent to $65,800,000 I'm very thankful for the effort and commitment by all of our teammates throughout Lancaster Colony that enabled us to deliver these strong results. In our Retail segment, net sales growth of 2% was driven by carryover pricing, volume gains for our successful licensing program, Continued strong performance for our New York bakery frozen garlic bread and increased demand for our Rheem's frozen egg noodles. Retail segment sales volume measured in pounds shipped declined 1.9%.

Speaker 2

Excluding the impact of a product down weighting initiative and our reduced commitment to private label bread, retail sales volume increased 1.2%. Specific to our licensed product, retail scanner data for the quarter showed Chick Fil A sauce is up 6% to 38,700,000 and Olive Garden Dressings up 2.1% to 34,400,000. Buffalo Wild Wing sauces were about flat at $19,300,000 which compares to a strong quarter last year when sales increased over 26%. Our category leading New York bakery frozen garlic bread saw sales growth of 4% to $88,700,000 for a share of $43,100,000 Sales of our Rheem's frozen egg noodles increased 17.9% to $16,500,000 to capture a 70.3 share of the frozen pasta noodle category. I'm also happy to report that Chick Fil A Refrigerated Salad Dressings, which we launched nationally last May, are also performing well with scanner data showing 9 point $4,000,000 in sales during the quarter.

Speaker 2

When combined with the sales of our Marzetti brand dressings, our refrigerated dressing sales have grown to represent a leading 27.7%. In the Foodservice segment, sales growth of 1.5% was led higher by demand from several of our national chain restaurant accounts along with volume growth for our branded foodservice products. Food Service sales volume measured in pounds shipped increased 4.6%. During the period, Food service segment net sales were adversely impacted by pass through price decreases, which resulted from commodity deflation. During Q2, we were pleased to deliver gross profit of $121,500,000 and a gross margin of 25%, an increase of 3 60 basis points versus last year.

Speaker 2

This increase was driven by favorability in our pricing net of commodities or PNOC Following 2 years of unprecedented inflation along with the beneficial impacts of our cost savings initiatives, Our focus on supply chain productivity, value engineering and revenue management remain core elements to further improve our financial performance. I'll now turn the call over to Tom Pigott, our CFO for his commentary on our second quarter results.

Speaker 3

Tom? Thanks, Dave. This quarter featured continued top line growth, improved gross margin performance and higher operating income. The gross profit and operating income results exceeded our expectations and set a second quarter record for the company. 2nd quarter consolidated net sales increased by 1.8 percent to $485,900,000 Decomposing the revenue performance approximately 1.5 percentage points was driven by volumemix and the remainder was driven by pricing.

Speaker 3

Pricing was favorable in the retail segment, but deflationary in the foodservice segment due to lower commodity prices. Consolidated gross profit increased by $19,400,000 or 19 percent versus the prior year quarter to $121,500,000 Gross margins expanded by 3 60 basis points to 25%. The gross profit growth was primarily driven by favorable PNOC performance and the company's cost saving initiatives. Commodity costs were deflationary versus the prior year, but remained elevated versus historical levels. Selling, general and administrative expenses increased 9.7 or $4,900,000 The increase reflects investments to support the growth of the business including higher consumer spending and increased brokerage costs.

Speaker 3

Consumer spending increased versus a low comparative period to support retail segment growth initiatives. Reduced expenditures for Project Ascent, our ERP initiative partially offset these increases. Costs related to the project continued to wind down totaling $2,000,000 in the current year quarter versus $7,500,000 in the prior year quarter. Consolidated operating income increased $14,400,000 or 28.1% due to gross profit improvement partially offset by the higher SG and A expenses I mentioned. Our tax rate for the quarter was 23.4%.

Speaker 3

We estimate our tax rate for the remainder of fiscal 2024 to be 23%. 2nd quarter diluted earnings per share increased $0.42 or 29 percent to $1.87 The net impact of the reduction in Project Ascent expenses was favorable by $0.15 versus the prior year. With regard to capital expenditures, our year to date payments for property additions totaled $37,100,000 For fiscal 2024, our forecasted total capital expenditures remain at $70,000,000 to $80,000,000 The forecast reflects a decline versus a prior year spending with the Horse Cave expansion project now substantially complete. In addition to investing in our business, we also returned funds to shareholders. Our quarterly cash dividend of $0.90 per share paid on December 29th represented a 6% increase from the prior year's amount.

Speaker 3

Our enduring streak of annual dividend increases stands at 61 years. Net cash provided by operating activities for the 2nd quarter was a robust $105,900,000 driven by the higher net income and reduced working capital. Our financial position remains strong with a debt free balance sheet $133,800,000 in cash. So to wrap up my commentary, our second quarter results reflected continued top line increases, record gross profit and operating income performance and investments to support further growth. I will now turn it back over to Dave for his closing remarks.

Speaker 3

Thank you.

Speaker 2

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 3 simple pillars of our growth plan. The number 1, accelerate core business growth. The number 2, simplify our supply chain to reduce our cost and grow our margins. And number 3, to expand our core with focused M and A and strategic licensing.

Speaker 2

Looking ahead to our fiscal Q3, we project retail sales will continue to benefit from our banding licensing program that will include contributions from the launch of Texas Roadhouse Steak sauces. I am also excited to share that we have added Subway as a new partner to our retail licensing program with an initial offering of 4 different Subway sandwich sauces, including their most popular sweet onion teriyaki. Both Texas Roadhouse Steak sauces and Subway sandwich sauces will begin shipping to retailers later this month. In the foodservice segment, we expect sustained volume growth from select quick service restaurant customers. Deflationary pricing is expected to remain a headwind for Foodservice segment net sales in the coming quarter.

Speaker 2

With respect to our gross profit, we anticipate some continued favorability in our PNOC, but at a sequentially lower level compared to our fiscal 2nd quarter. With respect to our ERP initiative Project Ascent, Following the successful completion of the implementation phase during our fiscal Q1, we are devoting our attention to leveraging the capabilities of the new system to strengthen our execution and support our continued growth. Finally, as we announced in December, We had a change in our Board of Directors effective January 1st this year with the appointment of Alan Harris as our Chairman replacing Jay Gerlach. Alan has served as a Director on the Lancaster Colony Board since 2008 and was appointed Lead Independent Director in 2018. While Jay is stepping down from his role as Executive Chairman, he will remain actively engaged as Director.

Speaker 2

I would like to extend my deepest gratitude to Jay for his leadership and many years of dedication to Lancaster Colony, both as an executive and as the Chair of our Board. Jay was appointed to Lancaster Colony's Board of Directors in 1985 and is the corporation's longest serving Director. I would also like to congratulate Alan on his new appointment. Both Jay and Alan bring extensive leadership experience and strategic oversight to our Board, which will continue to benefit our company and our shareholders going forward. This concludes our prepared remarks for today and we'd be happy to answer any questions you might have.

Operator

One moment. Your first question comes from Jim

Speaker 4

Yes. I wanted to start with the inflationary headwind on foodservice. I think if we back in, it's like a 300 basis point headwind in the quarter. If we think about the back half of the year, is that 300 basis point number a good kind of sticking point to think about? Or is it going to increase, decrease as we progress through the year?

Speaker 3

Hey, Jim. Yes, it's Tom. We expect it to increase a little bit. We're in the 300 to 400 basis point for the back half on foodservice deflationary.

Speaker 4

Okay. And is that

Speaker 2

And maybe just Jim, just a reminder on that, that Just as the way it went up, when it goes down, it's a mark to market pass through. So it's sort of A no harm event on gross profit that also drives modest margin accretion as we've talked to you about in the past. It's just one of the nuances of that business in our portfolio.

Speaker 4

Right, great. Yes, that's helpful context. So that's broad based across the portfolio. It's not just like a few key accounts that's just kind of the whole foodservice?

Speaker 2

No, and it's really driven by our basket of commodities, soybean oil first among them on that part of the business. Okay, great.

Speaker 4

Maybe one other question. You guys got a nice lift from PNOC in the quarter, obviously. Think about it stepping sequentially down. As we think about back half gross margins, should it be somewhere between Kind of 1Q and 2Q's level or do we expect it to step down below what 1Q was? I think it was like 23 23.5% Q1 adjusted?

Speaker 3

Yes. So, yes. So, Jim, I'll answer your question kind of as a versus prior year. So if you look at the first half, we were up 200 basis points versus prior year on gross margins. As we look at the back half, we expect it to moderate or more in the $150,000,000 to $200,000,000 but This is very much dependent on the commodity basket and how things play through.

Speaker 3

From A tailwind perspective, we are seeing some commodity deflation in our forecast and we're seeing some nice supply chain productivity results and those are baked into our outlook in the back half.

Speaker 1

Okay, great. Thanks guys. I'll pass it on.

Speaker 2

Thanks, Tim.

Operator

Thank you. One moment for our next question. Your next question comes from Alton Stump of Loop Capital.

Speaker 5

Great. Thank you. Good morning. And I would also like to your comments, Dave, as it pertains to Jay, having known him for almost 20 years, great to that he is taking his next step and will still be involved with the company and also congrats on the quarter of course as well.

Speaker 3

Thank you. Thank you. So that's your regards on to Jay.

Speaker 5

Great. Thank you so much. I want to ask about the subway announcement, which you kind of slipped in there Pretty quickly there, Dave. I mean, that's obviously seems like pretty good news, if not huge news. You've had several major announcements over the last couple of years.

Speaker 5

I know we talked about this before, but How much of an impact do you think the huge success you've had over the last couple of years with Chick Fil A is having on whether Texas Roadhouse, Subway, Arboretum, etcetera? I would have to think that that has led to an increased incentive for these guys to reach out to you and say, hey, can we do something similar to what you're doing with in this case Chick Fil A. I guess, maybe just some color on all this recent snowball of course new sign ups you've gotten, how much of that think if not directly, certainly indirectly is a result of the big success you've had with Chick Fil A?

Speaker 2

Yes. I think as we've I've shared with a lot of the covering analysts on the phone and you all, Olive Garden was our first foray into the space and together with Darden Restaurants and Olive Garden, we learned our way through this. And what we learned 1st and foremost is that the proposition in retail was relevant and second that the proposition could actually be net creative to the foodservice business in terms of the positive perception around the brand. Fast forward, as we've moved Beyond Darden and obviously continued to nourish that relationship, but added Buffalo Wild Wings and Chick Fil A, I think it's just allowed us to demonstrate this proposition a little bit more broadly. Texas Roadhouse was a collaborative conversation.

Speaker 2

It was actually brokered by one of our big customers in retail. And then Subway was one that was an inbound conversation as well. It's an interesting time and I think it's a manifestation of the fact that the lines between retail and foodservice are blending. We're seeing more occasions that are at home And our partners out there in foodservice are becoming increasingly open to this idea. And on the retail side, I think our important partners be they Kroger, Walmart or Publix or whoever like the idea of bringing relevant new items to these categories.

Speaker 2

So, it's nothing no tree grows to the moon, but I think our intention here is just to continue to work carefully to look for good partners where we line up at the values level. We're looking for long term relationships in this space And we're going to try to see how far we can take this. We do have a pipeline of other folks that we're talking to. We're not ready to share with you now because these conversations take time. And we're even starting to look at categories beyond Things that are necessarily sold in the restaurant and maybe even other categories than we played in today.

Speaker 2

So I would love to tell you we have another Chick Fil A on the hook, but I think we all know there's just one Chick Fil A out there. But I think this in conjunction with how we're thinking about organic innovation And M and A into the future hopefully will give us a balanced sources of growth for our retail business that allows us to compete in the top quartile of our peer group and that's really our long term aspiration.

Speaker 5

Great. Thanks for that color. And then I guess just As a follow-up on that, obviously, of course, the Horse Gate facility is up and running now. It's your biggest facility. Is that also playing a role in just being able to be more aggressive in signing new partners because obviously I think you had some pretty meaningful capacity constraints prior to that facility opening?

Speaker 2

Well, that's correct. We were constrained on retail bottle capacity. And then also just the SAP implementation created a lot of organizational noise. So one of the things that we've been happy to be able to focus on in fiscal year 2024 is just really getting back to the basics of focusing on good execution. The theme for this fiscal year is execute to grow.

Speaker 2

And I think it captures the essence of both elements there, right. Good execution in our plant, Focusing on our GMPs be they safety and quality, good execution in the plant around productivity and then making sure that we do this in a way that we can work our way through the external circumstances with where consumers are to achieve growth at the higher end of our peer group. Great.

Operator

Thank you. And then, one last one and then Hop back in the queue, I

Speaker 5

guess this is probably for Tom. But Tom, just to make sure on your comments on the gross margin front, because obviously, look at the first half of the year, The bulk of that, as mentioned, 200 plus basis point growth came here in 2Q. So as I think by your comments about 150 to 200 points. It seems to say that basically that you think that the back half could be similar to maybe a bit lower of an increase year over year versus The full first half of the year, just not a huge increase, obviously,

Operator

360 basis points, I think, if my math

Speaker 5

is right, that we saw here Am I right on that?

Speaker 3

That's correct. And I think part of the reason is that as you get into Q4, there's less Our expectations based on our commodity outlook and our pricing models, we don't expect a strong PNOC performance year over year in Q4 versus Q3 and what we experienced in Q2.

Speaker 2

In the retail business, Alton, we continue to have the benefit of pricing. And the pricing, as you might imagine, in this environment is winding down. So that's going to continue to diminish during the period. We'll continue to see favorability on the commodity side. But when you put pricing and the commodities together, that's the reason why we expect to see this diminish marginally.

Operator

Got it. Great. Thank you

Speaker 5

so much, Tom and Dave for the help.

Speaker 2

Of course. Thanks, all. Thank you.

Operator

Thank you. One moment for our next question. And our next question comes from Robert Dickerson of Jefferies.

Speaker 6

Great. Thanks so much. Good morning, everyone.

Speaker 2

Hey, good morning, Bob.

Speaker 5

Yes. Nice to hear from

Speaker 6

you. Got a few questions, try to keep it quick. I guess just kind of on the back of your last comment On pricing in retail and how that kind of rolls off, which I totally get. Like could there be some kind of price deflation on your end in retail in the back half? I'm just thinking through Maybe some kind of investment needs given kind of a broader backdrop right now on the promotional side from a lot of companies within retail.

Speaker 6

And then also, I mean, it seems like there's a little bit of a maybe a more challenged comp, let's say, last Q3? That's the first question.

Speaker 2

Yes. So great question. So what you're going to see is still some marginal pricing that plays through. On the deflationary side of pricing, We started to see these trends of softness emerge, let's say, in November and into December. And really at that point in time, Rob, we started to put plans in action.

Speaker 2

So for those of you that are tracking weekly data, we went out on Olive Garden for example and we took Our entry price point size is 16 ounce where at Walmart it had floated above $4 and we supported the price down into like at 395 price point I think is worth at on the shelf right now. We also made adjustments. It was a sort of a game time audible On Sister Schubert where we had planned actually to take our promoted price point from the prior year at 2 for 7 up to 2 for 8 Predicated on the softness we are seeing out there in the consumer environment we actually communicated with retailers we wanted to roll back to 2 for 7 and obviously they were happy enough to honor that. So that wouldn't show up as a decrease versus the prior year, but it was Let's say a decrease versus our own algorithm internally. Those are probably cases and points of other areas where we're Going out, we're selectively looking brand by brand at the entry price point that matters.

Speaker 2

Is it our GAAP versus private label that matters? Is in our promoted price point that matters and we're putting support in there. So I think what you're likely to see is a marginal tick up in trade support, But you're going to likely see some hopefully some volume offsets on that. And what we're trying to do is long term orient ourselves towards household penetration, which we think is really probably the more important metric to watch when it comes to the health of the business. And then again just brand by brand go in and tune things up a little bit just to make sure the brand sits at a good place.

Speaker 2

Sister Schubert is an interesting one if I could go deeper. So we elected to take the promoted price point back down to 2 for 7. Parenthetically, we are also in the throes of going through the product down weighted on that where we went from an ounce and a half per roll down to an ounce and a quarter, which is pretty consistent with what the industry is anyway. We didn't have one complaint during the season. And so we were able to address lagging margin issues we'd had on that business as we had skyrocketed, but we felt like it was more important to watch our promoted price point.

Speaker 2

So it's that's how we're handling it. But your original question which I think is an important one, I would say marginal upticks On trade, but at this point given our categories, we don't see a wholesale reset. I

Speaker 7

I worked for

Speaker 2

a long time for Bill Johnson and he had this saying, profitless prosperity. And I think we're all just somewhat cautious just about over investing and chasing things down. So we feel like watching household penetration is a good strategic way to think about this and then making those investments that really protect for the short term and the long term. So you ask a short question, I gave you a long answer. I apologize.

Speaker 6

Yes, it's usually the other way around.

Speaker 2

I appreciate

Speaker 8

that. Okay. And then I guess When

Speaker 6

I look at your dressings and sauces business, which clearly has a higher margins, clearly been going great for you. Kind of over time, it seems like there's maybe like a little lift with the launch, things do well. But at the same time, it seems like recently maybe like frozen breads are kind of driving more of the growth than dressings and sauces. So I'm just curious like the licensing dynamic has been going great for you in retail.

Speaker 2

At the

Speaker 6

same time, like have you seen any recent shifts in consumer behavior? Like I totally appreciate your prior comments Some of the price pack architecture and driving household penetration that's key. But at the same time, I'm just thinking like we keep hearing kind of value seeking consumer. Yes. It's maybe buying more, I don't know, frozen dinner rolls and they're buying amazing

Speaker 8

Maui Subway sauce. I don't know. Yes. Yes.

Speaker 2

So it's a now this one's a bigger question. So I'll try to keep the answer, Chris, because I know we're on a timeline here. Maybe we'll take them a category at a time. I think we're in a season where New York, Texas toast is particularly relevant because that spaghetti and meat sauce meal occasion is a good value for consumers. And our team has done a nice job of using digital marketing to make sure that we're working with our big retailers to try to get into that basket.

Speaker 2

So on a for example, on one of their shopping apps, if they see pasta going in and Pasta sauce going in, they're going to be presented with sometimes it's just the brand, not even a coupon and what we find is that there's really solid conversion on those occasions, but on Toast highly relevant in this season. On rolls, I think we There again, it's relevant. I don't know in the case of Sister Schubert, if I would say that, wow, it's right in the sweet spot of a recession if we ever got there like toast is, but I would tell you as consumers eat at home, it's a great product and it rounds out the rest of a great meal occasion. On our sauces, I think we're seeing some cases of trade down. We're not different than any of the others.

Speaker 2

What you're seeing is a trade down from traditional food into, for example, the mass In some cases, mass merchants down into discounters from larger sizes to smaller sizes, affluent consumers are going to club. So we're seeing a lot of that and we're sort of monitoring that as it goes. On licensed sauces, you got couple of things going on, Chick Fil A sauce is continuing to grow in the mid single digits, albeit off of the pace that they were on before. I think that is so unique that consumers are continuing to support it. We did see some softness on Olive Garden Consumers traded out, we could watch them trade from larger sizes, small sizes and small sizes out.

Speaker 2

That's why we went in and made That price point adjustment, we feel like we're in a good place there. Buffalo Wild Wings and Arby's were For all intents and purposes really launched and supported last year, Buffalo Wild Wings at this point in time, we were getting tens of 1,000,000 of dollars of Free advertising on TikTok and you're going to note if you're looking at weekly scanner data, we're going to have a rough few weeks, probably more like 8 weeks As we comp that period, the business still year on year is up more than 25%. So and if you look at on a 2 year stack, it's up considerably more than that. So in this case, I don't think it's whether or not the proposition is relevant. We have some hard comps.

Speaker 2

Things like Arby's, A really unique SKU, a unique occasion, we got crazy support from retailers last year behind this. And this year without the support it's not selling quite as well off the shelf. What I would maybe ground on with every one of these Rob is we're trying to look at is the velocities of the item and where do they play in the greater condiment space and all of these play in the top quarter of the category in terms of velocity. So we feel like some are they're the Mickey Mantle's of the lineup And some of these are maybe more position players, but all of them seem to have an important role with our retailers. And again, hopefully that gives you some of the flavor or the context you were looking for.

Speaker 6

Yes. No, that was even better than the last I'll

Speaker 2

pass it on. Thank you.

Speaker 5

Thanks guys.

Speaker 2

Very good. Thank you, Rob. Thanks, Rob.

Operator

Thank you. One moment for our next question. And our next question comes from Brian Holland of D. A. Davidson.

Speaker 7

Yes, thanks. Good morning. So I wanted to ask

Speaker 2

Good morning, Brian.

Speaker 7

Good morning. I wanted to ask about the PNOC trend. So You know, egg on my face for not modeling this appropriately in Q2 and accounting for, hey, a more normalized environment means You get some mix benefit as well skewing towards retail in 2Q. But I just want to make sure if we kind of disaggregate the mix benefits kind of flowing through in a normal year versus PNOC. Is the PNOC Spread widening and becoming increasingly favorable if we look to recent quarters to Q2.

Speaker 7

And if we think about the back half, is the commentary that the PNOX spread narrows relative like 2Q was a peak PNOX spread or the second half a little bit more commentary more about The mix impact where lower margin foodservice is a higher percentage of your total net sales, if that makes sense.

Speaker 2

Yes. Well, let me take a I'll take the first crack at the answer, Brian, and then I'll turn it over to Tom maybe to to go even deeper. And first thing I would tell you is, I don't think you have egg on your face in this case. I think one of the hard things about this Past quarter, really the last 6 months for all of us has been trying to forecast where commodities are going to go. Soybean oil, for example, if we were looking at where was soybean oil in September, well, in September soybean oil was more than $0.60 and that right now it's Soybean oil has been pretty precipitous.

Speaker 2

Over that same period of time, if you looked at wheat, let's say in August, wheat would have been trading somewhere between 70750 right now, it's like at a 588. So again, a pretty steep fall off and corn is falling off even more. So I think One of the things that's made call on it harder this time within this narrow window is I think we've seen commodities come off more aggressively than maybe we were anticipating. We've been pleasantly surprised and I think if anything that probably impacted things. If you look at just This is one of the tie outs we did and maybe Tom I'll let you talk about versus where they were modeling in terms of consensus and where we came out favorable Maybe the sources of that variance in broad strokes.

Speaker 3

Yes. So Brian, to build on Dave's point, I think what we saw versus At the time we talked to you last, we saw favorability in soybean oil, flour and grain, eggs. All of those contributed to the favorable PNOC performance versus our expectations as well. And I think as Dave hit on, we're very cognizant of making the appropriate reinvestments to protect the business on trade and That's something that will continue to evolve as the year progresses. But to get to your question in terms of the flow of the PNOC, And Dave mentioned this earlier, we're in a space right now where you have more carryover pricing in retail and the commodity favorabilities that we accreted this quarter.

Speaker 3

As you progress further, there's less of that carryover pricing and there's a bit of a need to reinvest. So, to get to your question, I think Q2, from when we look at our PNOC projections is the strongest quarter of the year and Q3 will be favorable and then less so in Q4 based on This is all based on our commodity outlook, our projections for trade reinvestment, which can change, but that's how we're looking at it right now.

Speaker 2

And I think modeling the business, Brian, that commodity deflation continues and the PNOC notwithstanding, I think what you're going to find is that as commodities come down, it's going to be a mark to market in foodservice with very modest margin improvement just because obviously the way the math flows. But we do expect the overwhelming majority of the deflation to Stick on the foodservice business. So you're going to see our season, the retail business, which means you're going to drive retail margin improvement, which when you guys if you haven't got a chance to go through The Q, you'll see that broken out in there in more detail. So I think the mix of the businesses in terms of margin, our hope is that this commodity deflation inflation sticks, we should begin to see our retail business revert to some of the historical margins that we've had there.

Speaker 7

Thanks, David, Tom for the color. That's helpful. Just to put a button on that then, as we look towards the second half of

Speaker 2

the

Speaker 7

year, The PNOX spread tightening is more about pricing fading and maybe more trade and Assuming just continued sort of stable commodity prices, is that the directionally Yes.

Speaker 3

I think that's directionally The way we're looking at it, yes.

Speaker 7

Okay, great. And then the SG and A was up more than I was forecasting. It was a source of deleverage. I know you called out consumer investment. So maybe Dave, use this opportunity twofold.

Speaker 7

1, Just state of the consumer in the retail channel and behavior of the retailers, what you're seeing there as far as And I know you did mention some of this earlier with some of the pricing and the trade that you're doing. But is the expectation in the second half the year that in that SG and A line we need to increase. I know that's something you teased last quarter. It's potentially something where you would have to step up on. Is that did that come through fruition in Q2?

Speaker 7

And should we assume that that maintains maybe a source of deleverage in the second half of the year consumer investment?

Speaker 2

Sure. So the consumer investment, if you remember last year, we were light in the first half, heavy in the back half. This year, we told you when we started, we were going to be normalizing that spend across both halves, right. So What I would expect on the consumer side is that our spending will not go up period on period because it was actually elevated last year, Right. We don't have any intentions of pulling it back.

Speaker 2

But if you're looking at just consumer support below the line, we don't have intentions right now of elevating that. So when you look at our total spending on a year, you're going to see us elevated because we have it up a little bit earlier on.

Speaker 7

Perfect. I'll leave it there. Thank you.

Speaker 2

Okay. Very good. Thank you, guys.

Operator

Thank you. One moment for our next question. And your next question comes from Andrew Wolf of CL King.

Speaker 9

Thank you. Good morning and congratulations as well. I'll say Thank you. Maybe I'll take Soybean oil out of my face or something, but

Speaker 2

It's all good. It's a big commodity for the whole food complex.

Speaker 9

I know. On the PNOC To start with Elyse, just on the 360 basis point expansion in gross margin year over year. Correct. Either Give us the actual size or maybe a sense of the size like PNOC, like how much would you allocate to PNOC versus Some of the value engineering that you spoke of such as the downsizing the units Yes. So

Speaker 3

the PNOC was a little over 200 basis points And the cost savings initiative was a little over 100 basis points. That's kind of how it played through the P and L.

Speaker 9

Got it. And now in that 100 basis points for the everything for the value engineering and All the stuff, horse cave running much better. Right.

Speaker 2

What is that is that fairly sustainable for a while? Because I mean

Speaker 9

there's a lot of little things in there, whereas the PNOC is just sort of market determined more or less. Yes. How are you as you talk about the total You're not coming down because of the market and just the way the industry is. And what about the second even though it's 100 bps plus, how much how Do you see value engineering and other cost savings?

Speaker 2

Yes. So I think what we've told you in the rest of covering analysts is that we We're shooting for about $20,000,000 of cost out every single year. And I think that remains true. How we get that from period to period, it's going to evolve This time around was a little heavier on procurement and logistics, where we were able to use some of the softness that's out there for line haul on ambient and temperature controlled trailers to generate some sources of savings. We did have some benefit in productivity, but it was lighter.

Speaker 2

Manufacturing productivity, excuse me, as we sort of look going forward, I think what you're probably likely to see in the out years out periods is Things like logistics, we're running bids as we speak now to capitalize on the favorable rates. We'll lock in those savings and we'll look to source more savings coming from the manufacturing side and value engineering. That downsizing initiative that we illustrated is a good example of one where we felt like strategically was not going to diminish the consumer experience in any way. And it was just a prudent move to put in place to get the margins a little bit closer to where they had been historically. So It gives you a sense, I hope.

Speaker 9

Absolutely. And the other thing I wanted to ask about PNOC regards the it's going to be less of a contribution going forward. So I just want to make sure for us modeling Outside of the company, when you're saying that, are you thinking sequentially? Are you saying the year over year contribution? Because the 3rd quarter Year over year.

Speaker 9

So the 3rd quarter is the 4th quarter, lower quarter than the 2nd quarter. So I mean, we can make whatever deduction Yes, we're doing it year over year.

Speaker 2

Yes. And Andrew, I think the watch out just to make sure that we remain aligned is that if you look at the last Probably 18 months, our PNOC has been driven by a capital P, PNOC with pricing, Food service pricing that was market to market and retail pricing. Now as we look forward, that's the P is going to go small P on us. That's what we're talking about. What remains to be seen is what's going to happen on these commodities, right.

Speaker 2

Because One of the unique things about our company is we took on 2 years of 20% inflation. And I think we told you guys it was $160,000,000 a year. Look at the deflation that we've seen, it's still a very, very small component of the overall inflation we saw last couple of years. So As if commodities continues to deflate board and basis on soybean oil, we see an important component because of our pasta and breads And then transportation rates remain where they are. We didn't even get into the cost of diesel fuel, which is I don't know $0.70 $0.75 versus where it was last year.

Speaker 2

As long as we continue to see room for those commodities to run, We could see commodity deflation. So how we get PNOC will be different than it's been in the past, but we don't expect to see pricing at this point in time. That's one thing our retailers wouldn't want to hear from us about is if we came to the door and said we'd like to take a price increase.

Speaker 9

Okay, that's understood. And if I could just ask a couple of volume questions before I stop asking questions. So first in the retail, there was like over a 300 basis point swing. Yes. When you take out the impact from some discontinued private label and the down weighting.

Speaker 9

And also

Speaker 1

the same question as before, can

Speaker 9

you kind of allocate between the 2? And I guess give us a sense of what the outlook is there. It's good for profits, but not obviously. And I guess what it's saying is that the tonnage is kind of distorted because the units are a lot better when you down weight.

Speaker 2

Yes. If you look at the units, it's a different It's a slightly different picture. We're still seeing a deceleration on units. But Dale, why don't you go ahead?

Speaker 1

Yes. So Andrew, the down weighting was about 2 thirds of it and then the other third was the private label.

Speaker 9

Okay, got it. And I just want to underline something. You mentioned that Sister Schubert was kind of following the category, there's not a much competitive risk. I mean, is that sort of what the industry is up to right now? It would make sense in this environment.

Speaker 9

But is this down weighting pretty widespread and you don't feel you're going to be leading yourselves into like a competitive disadvantage?

Speaker 2

No, no. I think when we've done these in the past, Andrew, and we've done a handful. I mean, we haven't done a ton of them. But ordinarily, what we're doing is we're moving into the industry standard. We haven't done these where we've led the industry down.

Speaker 2

So we've certainly conformed. Now on Sister Schubert, which is one where we made those adjustments, I would tell you, if I look at the category trends, the period ending at the beginning of November, October 29, the 13 week and the 4 week period, last 4 weeks or so, it's continued to perform better than where it was before that. So I think this is an occasion with a little bit of tailwind and I think that's a question that Rob was asking. So we are seeing just given the environment a little bit of tailwind and we're getting our fair share of it.

Speaker 9

Got it. The last thing, this will be it's a follow on to that. So I guess, the better sharper price point helps the units. How is the per unit profitability for you And for the retailer, like profit pennies per item?

Speaker 2

Yes. Penny profit, I would tell you from the way we've talked about it really with you guys is more in terms of our margins. And I think The margin story on retail is the important point and you can infer that we're making more profit per unit because the margins are improving on those. Retailers, what I would tell you is what we're not seeing is them marching up on us. So I would say there's no reason to think that their penny profit is changing in a big way.

Speaker 2

I think as we were looking at other categories in the event we were working against private label heavily. I think the watch out is there's a propensity sometimes for them to margin up on the brand as a means by which to drive incremental penny profit off of a branded player and then drive trade down to private label and They have the price point architecture, right, they can win there as well. In most of our categories, you roll through produce, that's not an issue. If you look at our sauces and licensing, not much of an issue. You move around to our bread items, it's a watch out, right?

Speaker 2

If you look at our frozen noodle business, not much of an issue in there. So if I had to guess their penny profit, I would guess it's Pretty consistent. But I think if I was working at 1 of the other mega cap CPGs where Tom and I work together, We may be thinking differently about this. Is that my guess is that's a hammer that they're using to get their big brands to conform to their aspiration.

Speaker 9

Okay. Well, it sounds like you guys are managing that those category situations pretty well. So thank you.

Speaker 2

We're certainly we're doing our best. And I think your point is an important way to think about it too with some of these brands because you have to for all of us on this side, broken head manufacturer, we need to put ourselves in the shoes of our big retail partners. And I think the corollaries, they can make more penny profit per item, but if they're not careful, They trade consumers down and they drive their category down, which they usually don't like as well. So it becomes kind of a holistic story, which is what's overall health of the category, what's the health of their shopping basket and then what's their penny profit like. Got it.

Speaker 9

Thank you.

Speaker 2

Of course. Thanks, Andrew. Thank you.

Operator

Jim comes from Todd Brooks of The Benchmark Company.

Speaker 8

Hey, thanks and good morning to you all.

Speaker 2

Good morning, Todd.

Speaker 9

Good morning, Todd. Good morning.

Speaker 8

Couple of questions for you here at the end of the call. First, and thank you for highlighting on the PNOC side that this becomes more the seed Then the P going forward, if we look at retail pricing, Dave, in the past, you've talked about not necessarily Chasing incremental volume by lowering pricing. And I'm just wondering, flipping what you just said about Your retailer is not looking for incremental pricing increases from you. If you look at customer elasticities right now at retail, Your thoughts on holding the price, it looks like if you normalize the volume trends, volume trends are pretty good, which I think would argue that Maybe there's some confidence in the ability to hold pricing at retail going forward, but would love

Speaker 3

to get your thoughts on that.

Speaker 2

So if you look at 5,200 and 13 down to 4 or 5 weeks, obviously, You can see the tension on consumers in elasticity. So that much is readily apparent. The elasticities on our products just aren't such that you drop out this price, you're able to get it back. You can't make enough you can't move enough volume. What we find is that there are certain occasions like on price points where if we can get below a cliff you can get significantly more benefit than you might imagine just in the simple elasticities.

Speaker 2

I'll give you I'll go back to the example that we provided around that $4 price point. Our elasticity models probably would have predicted a pickup of X and we saw a pickup on that move that was somewhere so far between 2.5x to 3x of what would have been predicted. So in that case, it made sense. And what we also try to do in those conversations with our retailers is, obviously, we're at the table with them and We're trying to figure out how to make our brand healthier, but also make the category healthier. And in this case, our customer partners said, hey, if you're willing to make this investment, I'm willing to make some investments and give you I'm willing to make some investments and give you end caps.

Speaker 2

So what you're likely to see for a brand like Olive Garden, which I mentioned here, but some of our other brands as you're going to see more support in the back half of the year on things like end cap, where if we can make a reasonable investment and get Support in things like NCAP feature and display, there again, you're going to get far better performance than your elasticities would necessarily project. So that becomes part of what we're trying to do, right?

Speaker 8

Yes, absolutely. And then my second question and obviously we're all surprised by the gross margin performance in the quarter, which was great to say. I guess with the magnitude of the bounce back, In the past, you've talked about listening getting back to 26%, 27% gross margins without a meaningful correction in commodities Would be difficult to do. We've seen a correction. I don't know if it qualifies as how you would label it meaningful.

Speaker 8

But with to the lift that we saw in Q2. Can you just talk a little bit longer term about your thoughts on in this type if we stay in this type of Commodity environment that we're in right now, what do you think the gross margin potential for Lancaster is? Thanks.

Speaker 2

Yes. Well, what we've said is our aspiration is to get the business to the midpoint of our peers. We still think that's doable. As it pertains to deflation, this is a tricky one because As goes soybean oil goes a big piece of our business and we've seen the more recent pullback on the board and I think what we're asking ourselves is, is this likely to stick? What drove this up early on?

Speaker 2

And Todd, I know you and I and Tom, others here had the conversation together was a policy shift towards renewable diesel fuel. So all of a sudden we saw incremental demand for soybean oil because it was being moved over to diesel fuel. Now we've seen a pullback The policy hasn't necessarily changed, but if you look at the board today going out to 2025, It's depressed out to about $0.44 so off a couple of cents versus where it is. What we're trying to figure out is that because that's a correlation between a fall off on let's say crude oil, which is also soft and you guys are looking at it as much as we are, what's it trading at about 76 dollars a barrel today, right? Or is there some sort of anticipation that after another election we may see a policy change?

Speaker 2

It's just really hard for us to guess, but I think in order for us to get to revert back to that point that you're talking about, we're going to have believe that there are structural reasons for oil to remain low, both on the soybean oil, not oil, but soybean oil to be low both on the board and on basis. And once that day comes true, I think, yes, then we're going to have more confidence to say a lot of this cost that we've taken on structurally is going to come off. Now, here's what I would tell you, what we try to do in the meantime is when we see pullbacks, We try to buy opportunistically with forward agreements and lock in some of the favorable pricing Because what we don't know is, hey, is there going to be another shoe that drops a bad crop in Brazil, a bad soybean crop in the because weather is something else. So what we're trying to do as this plays out is by when there's an advantaged opportunity to lock in favorability until we get to a point where the policy side of it works itself out.

Speaker 8

Knowing that Your ability to contract and lock going forward and strategies around that varies based on price and the ability to do so. Tom, if you're looking at the commodity basket, second half of the year, which I would expect you have pretty good visibility into at this point, How does it compare to the 2Q reality on kind of the commodity piece of PNOC?

Speaker 3

Yes. We're looking at deflation at similar levels with some moderation in the 4th quarter. But There are pieces that you really can't forward cover like the basis we pay to process The soybeans, things like eggs are more difficult to so there is just cautioned. It's like there is some There's some unpredictability in all of this, but that's the outlook we have.

Speaker 2

Yes. Tom makes a great point. We're all keeping our eyes on what's happening with ABI, the avian influenza that's out there.

Speaker 8

Okay, great. Thank you all. Congrats.

Speaker 2

Thank you.

Operator

Thank you. One moment for our next question. And our next question comes From Robert Dickerson of Jefferies.

Speaker 8

Hey guys, sorry, just a very easy quick follow-up.

Speaker 6

Hey. Just the balance sheet, right? I mean, you talked about in the script, cash balance is great, CFO was good. Coming to the quarter, clearly, you still have no debt. And some of these ERP initiatives clearly are rolling off.

Speaker 6

We think margins going up, I mean, assume kind of cash flow gets back to a pretty place and you don't have any debt. So I guess more from a managerial perspective, it doesn't seem like you have a tremendous amount of kind of organic Cash or CapEx needs outside of traditional working capital. So, any of us have been fairly quiet, let's say, for A number of years for some time on the acquisition front, but there could be some cash build. So maybe just maybe provide any incremental color that you can, as to how you're thinking about that cash just outside of the standard verbiage on dividends, etcetera? Thanks.

Speaker 6

That's it.

Speaker 3

Sure. Yes. So, I think we still see opportunity to invest in the business. We've made the big Investment in Horse Cave, which certainly helps us from a capacity standpoint. But as we look at kind of into the future, Certainly, there's automation opportunities that we want to invest in with the labor market remaining tight.

Speaker 3

And those are good return projects. So we'll continue to invest back into the base. That's always priority 1 and that's our best return and lowest risk investments.

Speaker 2

And then when you look at M and

Speaker 3

A, our strategy is to really look at opportunities where we can lever our core competencies Really in dressings and sauces is kind of our focus area. We see sauce category continues to be a nice growing space. And so we're going to continue to look at opportunities in that space to really continue to grow this area of dressings and sauces where we tend to have strong culinary capabilities, Nice retail sales team that's able to execute well. And with the Horse Cave investment, We have high speed lines and capabilities to produce at a very low cost. So that's the focus of our M and A strategy.

Speaker 3

And certainly now that we have the SAP project behind us, as well as the Horse Cave expansion, we're certainly more open to looking at opportunities to scale the business further.

Operator

Perfect. Thank you.

Speaker 1

You're very welcome. Thanks, Rob.

Operator

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

Speaker 2

Well, thank you everyone. We really enjoyed being with you today. We look forward to being with you again in May when we report our next quarter's results. Have a good rest of the day.

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Key Takeaways

  • Record Q2 results: Consolidated net sales rose 1.8% to $485.9 million, gross profit jumped 19% to $121.5 million and operating income climbed 28.1% to $65.8 million.
  • Retail segment growth: Net sales increased 2% on carryover pricing, volume gains from the licensing program and strong demand for New York bakery frozen garlic bread (+4%) and Rheem’s frozen egg noodles (+17.9%), while refrigerated dressings now hold a 27.7% share.
  • Foodservice performance: Net sales grew 1.5% with volume up 4.6%, though deflationary pass-through pricing from lower commodities acted as a headwind but still modestly accreted margins.
  • Margin expansion: Gross margin widened by 360 basis points to 25%, driven by favorable pricing net of commodities (PNOC) and over $20 million in annual cost savings from supply chain productivity, value engineering and ERP efficiencies.
  • Strategic outlook: The three-pillar plan—accelerate core growth, simplify the supply chain and expand via focused M&A and licensing—will guide Q3 launches of Texas Roadhouse steak sauces and Subway sandwich sauces plus ongoing ERP optimization.
A.I. generated. May contain errors.
Earnings Conference Call
Lancaster Colony Q2 2024
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