Business Context and Reporting Period
This Form 10-Q is for Lancaster Colony Corporation and subsidiaries, not Marzetti Co. It covers the quarter and six months ended December 31, 2015, representing fiscal 2016. Lancaster Colony manufactures and markets specialty food products for retail and foodservice markets, primarily in the United States, through its Specialty Foods reportable segment.
The company acquired Flatout Holdings, Inc. in March 2015 for $92.2 million, funded with cash. Flatout manufactures flatbread wraps and pizza crusts and contributed approximately $9 million of sales in the quarter and $20 million year to date.
Key Financial Metrics
| Metric | Three Months Ended Dec. 31, 2015 | Prior Year | Six Months Ended Dec. 31, 2015 | Prior Year |
|---|---|---|---|---|
| Net sales | $324.8 million | $303.4 million | $618.9 million | $563.4 million |
| Gross margin | $83.6 million; 25.7% | $78.7 million; 25.9% | $151.6 million; 24.5% | $136.1 million; 24.2% |
| Operating income | $52.1 million; 16.0% | $50.2 million; 16.6% | $94.0 million; 15.2% | $84.8 million; 15.1% |
| Net income | $34.5 million | $33.0 million | $62.1 million | $55.7 million |
| Diluted EPS | $1.25 | $1.20 | $2.26 | $2.04 |
| Operating cash flow | Not separately provided | Not separately provided | $74.4 million | $83.0 million |
- Six-month operating cash flow declined despite higher earnings, primarily because of increased working-capital requirements.
- Cash used in investing activities was $7.8 million, including $7.4 million of property additions, compared with $14.0 million in the prior-year period.
- Cash used in financing activities was $161.8 million, principally due to a $136.7 million special dividend paid in December 2015. Total dividends paid were $163.1 million.
- Cash and equivalents decreased to $87.1 million at December 31, 2015, from $182.2 million at June 30, 2015.
- The company had no borrowings under its $120 million unsecured revolving credit facility. Standby letters of credit of $4.7 million reduced available capacity.
- Total assets were $603.9 million and shareholders’ equity was $482.6 million at December 31, 2015. Retained earnings declined to $1.118 billion from $1.219 billion, primarily reflecting the special dividend.
- The six-month effective tax rate was 33.8%, compared with 34.3% in the prior-year period.
Material Changes Versus the Prior Comparable Period
- Quarterly sales increased 7% and six-month sales increased 10%, driven principally by Flatout, higher foodservice volumes, pricing actions, and lower new-product placement costs.
- Excluding Flatout, sales increased 4% for the quarter and 6% year to date.
- Retail sales rose 7% for the quarter and 11% year to date; foodservice sales rose 7% and 9%, respectively.
- Volume, measured by pounds shipped, increased 4% for the quarter and 6% year to date.
- Gross margin percentage was broadly stable. Benefits from lower freight, soybean oil, dairy-based ingredient, and placement costs were offset by higher egg costs, increased retail trade spending, and less favorable mix.
- SG&A increased 11% for the quarter and 12% year to date, reflecting higher volumes, Flatout-related consumer and trade activity, and amortization of acquired intangible assets.
- Operating income increased 4% for the quarter and 11% year to date. Specialty Foods operating income increased 4% and 11%, respectively.
- Net income increased 5% for the quarter and 12% year to date, while diluted EPS increased from $1.20 to $1.25 and from $2.04 to $2.26, respectively.
- The company adopted retrospective balance-sheet classification for deferred tax assets and liabilities, with no income statement impact. The June 30, 2015 presentation reclassified $12.8 million of current deferred tax assets to noncurrent deferred tax liabilities.
Guidance, Outlook, Risks, and Unusual Items
- Management expected fiscal 2016 capital expenditures of approximately $15 million to $20 million and believed operating cash flow would fund capital needs.
- For the third quarter, management expected pricing actions to offset higher egg costs, assuming no recurrence of a widespread avian influenza outbreak. Egg prices were trending down from recent peaks, and other commodity and freight costs were expected to remain modestly favorable.
- An initiative to selectively rationalize portions of the foodservice business was expected to slow future foodservice sales growth.
- Product placement, marketing, and promotional costs were expected to increase in the second half of fiscal 2016 to support new product introductions.
- The Easter holiday was expected to affect third-quarter comparisons, similar to the prior year.
- Key risks include avian influenza and egg costs, commodity and packaging inflation, customer and consumer response to pricing, customer concentration or loss of major programs, product recalls, new-product acceptance, freight and energy costs, capacity constraints, labor relations, litigation, pension funding, Flatout integration and growth, acquisitions, financing access, and financial-market conditions.
- Ordinary-course litigation was not expected to have a material effect. The company reported no material changes to previously disclosed risk factors and no material changes in market risk.
- During the quarter, the company terminated medical benefits under certain postretirement plans. The resulting negative plan amendment and remeasurement generated a $2.038 million pretax prior-service credit and reduced expected future postretirement benefit costs.
- The company was in compliance with its credit-facility covenants and expected to remain compliant. Management stated that cash, internally generated funds, and available credit should meet cash requirements through 2016.
- Disclosure controls and procedures were evaluated as effective as of December 31, 2015, with no material changes to internal control over financial reporting.
Important Facts for Investors to Verify
- Registrant identity: Verify that the intended filing is Lancaster Colony Corporation; the supplied metadata identifies Marzetti Co.
- Flatout contribution: Assess the sustainability of the acquired business’s sales, margins, amortization, and integration costs.
- Dividend impact: Consider the effect of the $136.7 million special dividend on cash, retained earnings, and future capital allocation.
- Commodity exposure: Monitor egg prices, avian influenza risk, other ingredient costs, freight, and the effectiveness of pricing actions.
- Foodservice rationalization: Evaluate the effect of selective business rationalization on sales growth and profitability.
- Liquidity and credit facility: Confirm available borrowing capacity, standby letters of credit, covenant headroom, and the April 2017 facility expiration.
- Cash-flow conversion: Reconcile the decline in operating cash flow with higher earnings and assess working-capital trends.
- Accounting and benefit changes: Review the deferred-tax reclassification, revenue-recognition implementation plans, and the postretirement benefit amendment.