Business Context and Reporting Period
This Form 10-Q is for Lancaster Colony Corporation and Subsidiaries, not Marzetti Co. The filing covers the quarter and six months ended December 31, 2017, within fiscal 2018. Lancaster Colony manufactures and markets specialty food products through Retail and Foodservice segments. The company’s fiscal year runs from July 1 through June 30.
Effective July 1, 2017, David A. Ciesinski became CEO and chief operating decision maker. The company reorganized its reportable segments into Retail and Foodservice; prior-period segment information was retrospectively conformed.
Financial Results and Key Metrics
| Metric | Three Months Ended Dec. 31, 2017 | Three Months Ended Dec. 31, 2016 | Six Months Ended Dec. 31, 2017 | Six Months Ended Dec. 31, 2016 |
|---|---|---|---|---|
| Net sales | $319.7 million | $326.8 million | $618.6 million | $618.1 million |
| Gross profit | $83.9 million | $93.7 million | $159.4 million | $174.4 million |
| Gross margin | 26.3% | 28.7% | 25.8% | 28.2% |
| Operating income | $47.3 million | $59.4 million | $91.6 million | $110.1 million |
| Operating margin | 14.8% | 18.2% | 14.8% | 17.8% |
| Net income | $45.9 million | $39.0 million | $75.3 million | $72.4 million |
| Diluted EPS | $1.67 | $1.42 | $2.74 | $2.63 |
- Segment sales: Retail sales were $179.3 million for the quarter and $341.4 million year to date; Foodservice sales were $140.4 million and $277.2 million, respectively.
- Segment operating income: Retail generated $37.3 million for the quarter and $70.2 million year to date; Foodservice generated $13.4 million and $28.1 million, respectively.
- Cash flow: Operating cash flow was $84.0 million for the six months, compared with $76.1 million in the prior-year period. Capital expenditures were $15.3 million, versus $11.8 million previously.
- Liquidity: Cash and equivalents were $178.8 million at December 31, 2017, compared with $143.1 million at June 30, 2017. Total current assets were $343.1 million and current liabilities were $85.1 million.
- Debt: No borrowings were outstanding under the $150 million unsecured revolving credit facility. Standby letters of credit of $5.1 million reduced available capacity. The facility expires in April 2021.
- Dividends and repurchases: Six-month dividend payments were $31.6 million, compared with $28.8 million in the prior year. Only 31 shares were repurchased during the quarter for tax-withholding purposes; 1,404,289 shares remained authorized for future repurchase.
Material Changes Versus the Prior Comparable Period
- Second-quarter sales declined 2%, while six-month sales were essentially flat. Retail sales fell 2% in the quarter but increased 2% year to date; Foodservice sales declined 3% in the quarter and 2% year to date.
- Gross profit declined 10% in the quarter and 9% year to date. Gross margin contracted by 240 basis points in the quarter and 240 basis points year to date.
- Operating income decreased 20% in the quarter and 17% year to date. Retail operating income declined 13% in the quarter and 10% year to date; Foodservice operating income declined 30% and 28%, respectively.
- Margin pressure reflected higher costs for eggs, soybean oil, dairy ingredients, garlic and freight, together with lower second-quarter volume. Raw-material costs reduced gross margin by approximately 2% of sales in the quarter and less than 2% year to date; freight costs reduced gross margin by less than 1% of sales in both periods.
- SG&A increased 7% in the quarter and 6% year to date, driven by personnel and strategic initiatives, Angelic Bakehouse-related amortization and recurring noncash charges. The prior-year quarter also benefited from a favorable nonrecurring corporate item.
- Net income and EPS increased despite lower operating income because of the Tax Cuts and Jobs Act. The company recorded an approximately $9 million one-time deferred-tax remeasurement benefit.
Guidance, Outlook, Risks, Contingencies and Unusual Items
- Management expected fiscal third-quarter sales to benefit from an earlier Easter holiday and anticipated volume-driven Retail growth supported by new products. Retail price increases were implemented to recover higher commodity and freight costs.
- Frozen garlic bread sales were expected to remain constrained through the third quarter because of production and supply disruptions. Corrective actions were underway.
- Foodservice sales were expected to remain challenged by sluggish restaurant-industry conditions, although selected national-chain volume growth and pricing actions were expected to provide support.
- Management expected some abatement in commodity and freight costs beginning in the third quarter, but costs were still expected to remain above the prior-year level for the balance of fiscal 2018. Lean Six Sigma savings, supply-chain efficiencies and pricing were expected to offset part of the pressure.
- Fiscal 2018 capital expenditures were expected to approximate $30 million, including capacity expansion at Angelic Bakehouse. Management expected operating cash flow to fund capital requirements.
- The effective tax rate was 18.5% for the six-month period, or approximately 28.3% excluding the Tax Act benefit. Management expected approximately 28.3% for the remainder of fiscal 2018 and approximately 24% in fiscal 2019.
- Acquisition-related contingent consideration for Angelic Bakehouse was $16.0 million at December 31, 2017, up from $15.0 million at June 30, 2017. The earn-out is based on Angelic’s fiscal 2021 adjusted EBITDA and has no stated minimum or maximum value.
- Ordinary-course claims and litigation were not expected to have a material effect. The filing states that risk factors were not materially changed from the 2017 Form 10-K.
- Key risks include ingredient, packaging and freight-cost volatility; production and capacity constraints; reliance on customers, distributors and transporters; restaurant-industry weakness; competitive pricing; product recalls; customer concentration; acquisition integration; labor and regulatory matters; and potential pension-related contingencies.
- The company reported effective disclosure controls and procedures and 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, because the request metadata identifies Marzetti Co.
- Underlying earnings: Separate the $9 million one-time Tax Act deferred-tax benefit and the estimated $14.5 million favorable total Tax Act impact on second-quarter and year-to-date net income from recurring performance.
- Margin recovery: Monitor commodity and freight costs, pricing effectiveness, and whether lean supply-chain savings offset cost inflation.
- Operational execution: Verify remediation of frozen garlic bread production and freight-capacity disruptions, as well as the expected Angelic Bakehouse capacity expansion.
- Foodservice demand: Track restaurant-industry trends, national-chain programs and the timing of contractual ingredient-cost pricing adjustments.
- Contingent consideration: Monitor changes in the $16.0 million Angelic earn-out liability and the related future cash obligation, which is based on fiscal 2021 performance.
- Liquidity and capital allocation: Confirm continued strong operating cash flow, approximately $30 million of planned fiscal 2018 capital expenditures, dividend growth and unused revolving-credit capacity.