Business Context and Reporting Period
This Form 10-Q is for Lancaster Colony Corporation and subsidiaries, including T. Marzetti Company, for the three months ended September 30, 2018, the first quarter of fiscal 2019. The company manufactures and markets specialty food products through Retail and Foodservice channels, with more than 95% of sales in the United States.
Key Financial Metrics
| Metric | Q1 FY2019 | Q1 FY2018 | Change |
|---|---|---|---|
| Net sales | $316.7 million | $298.9 million | 6% |
| Gross profit | $81.2 million | $75.5 million | 8% |
| Gross margin | 25.6% | 25.2% | 40 bps |
| Operating income | $49.1 million | $44.2 million | 11% |
| Operating margin | 15.5% | 14.8% | 70 bps |
| Net income | $39.0 million | $29.4 million | 33% |
| Diluted EPS | $1.42 | $1.07 | 33% |
| Cash dividends per share | $0.60 | $0.55 | 9% |
| Operating cash flow | $40.9 million | $38.9 million | 5% |
Net income benefited materially from the lower effective tax rate following the Tax Cuts and Jobs Act: 22.6% versus 34.2% in the prior-year quarter. Other net income was $1.3 million versus $0.5 million, primarily reflecting higher interest income.
At September 30, 2018, cash and equivalents were $217.9 million, total assets were $840.2 million, and shareholders’ equity was $674.0 million. The company had no borrowings under its $150 million unsecured revolving credit facility and had $5.1 million of standby letters of credit outstanding. Liquidity was therefore strong, with approximately $144.9 million of unused facility capacity before any potential expansion provisions.
Material Changes Versus the Prior Comparable Period
- Foodservice sales increased 13% to $153.9 million, while Retail sales were essentially flat at $162.7 million.
- Foodservice operating income rose 28% to $18.9 million, and its operating margin improved to 12.3% from 10.7%.
- Retail operating income increased 3% to $33.9 million, with margin improving to 20.9% from 20.3%.
- Gross margin benefited from pricing actions, lower trade spending and coupon expenses, lean six sigma savings, and operating efficiencies. These benefits more than offset higher freight and commodity costs, which management estimated reduced gross margin by approximately 1% of sales excluding pricing effects.
- Operating cash flow increased despite larger working-capital investments, including higher receivables and inventories.
- Capital expenditures paid were $9.7 million versus $8.5 million in the prior-year quarter. Financing cash outflows increased to $18.9 million, primarily because of higher dividends, treasury-stock purchases, and stock-compensation tax withholdings.
- The company adopted the new revenue recognition standard on July 1, 2018 without a material cumulative-effect adjustment. Other recently adopted accounting changes also had no material effect on financial position or results.
Guidance, Outlook, Risks, and Unusual Items
- Management expects fiscal 2019 capital expenditures of approximately $60 million to $80 million, including a frozen dinner-roll facility expansion in Horse Cave, Kentucky, expected to be completed in mid-2020.
- Management expects to fund planned capital requirements, the October 2018 acquisition of Bantam Bagels, dividends, and other needs with operating cash flow and cash on hand, and does not currently expect to borrow under the revolving facility during fiscal 2019.
- The second fiscal quarter is typically the strongest sales quarter because of the holiday season. Management expects benefits from new Retail products, pricing actions, improved trade spending, Foodservice volume growth, and additional Foodservice pricing.
- Commodity costs were expected to become more neutral beginning in the second quarter, while freight costs were expected to remain a headwind.
- On October 19, 2018, the company acquired all assets of Bantam Bagels for a base purchase price of $34 million, subject to post-closing adjustments, plus a performance-based earn-out. The acquisition was funded with cash and was not material to the reported quarter; purchase accounting remained incomplete at filing.
- The company carried $17.1 million of Level 3 acquisition-related contingent consideration associated with the 2016 Angelic Bakehouse acquisition. The earn-out is tied to Angelic’s fiscal 2021 adjusted EBITDA.
- Key risks include ingredient, packaging, freight and energy cost volatility; pricing and customer acceptance; customer and restaurant-industry concentration; capacity constraints; product recalls or labeling issues; acquisition integration; competition; labor and supply-chain disruptions; litigation; pension obligations; and regulatory changes.
- Management reported no material litigation impact, no material changes to previously disclosed risk factors, effective disclosure controls, and no material changes to internal control over financial reporting.
Important Facts for Investors to Verify
- Confirm the filing issuer: the supplied filing is Lancaster Colony Corporation, not an entity named Marzetti Co.; T. Marzetti Company is identified as a wholly owned subsidiary.
- Assess the sustainability of the earnings increase because the lower tax rate was a significant contributor to net-income and EPS growth.
- Monitor whether pricing, lean manufacturing savings, and lower promotional spending continue to offset freight and commodity inflation.
- Evaluate the durability of Foodservice growth, including the contribution from temporary supply issues affecting competitors and new customer business.
- Track execution and funding of the $60 million to $80 million fiscal 2019 capital program and the Bantam Bagels integration.
- Review the Angelic Bakehouse contingent consideration and the assumptions underlying its Level 3 valuation.