Form 10-Q Summary
Filing entity: Lancaster Colony Corporation and subsidiaries, not Marzetti Co. The filing covers the fiscal quarter and six months ended December 31, 2018. Lancaster Colony’s fiscal year runs from July 1 through June 30; the period is fiscal 2019 second quarter. Financial statements are unaudited.
Business Context and Reporting Period
Lancaster Colony manufactures and markets specialty food products through two reportable segments: Retail and Foodservice. More than 95% of products are sold in the United States. During the period, the company acquired Bantam Bagels, LLC on October 19, 2018, and Omni Baking Company LLC on November 16, 2018, using cash on hand.
Key Financial Metrics
| Metric | Three Months Ended Dec. 31, 2018 | Three Months Ended Dec. 31, 2017 | Six Months Ended Dec. 31, 2018 | Six Months Ended Dec. 31, 2017 |
|---|---|---|---|---|
| Net sales | $349.6 million | $319.7 million | $666.2 million | $618.6 million |
| Gross profit | $91.4 million | $83.9 million | $172.6 million | $159.4 million |
| Gross margin | 26.1% | 26.3% | 25.9% | 25.8% |
| Operating income | $61.2 million | $47.1 million | $110.3 million | $91.3 million |
| Operating margin | 17.5% | 14.7% | 16.6% | 14.8% |
| Net income | $47.9 million | $45.9 million | $86.9 million | $75.3 million |
| Diluted EPS | $1.73 | $1.67 | $3.15 | $2.74 |
- Retail sales increased 4% for the quarter and 2% year to date. Retail operating income increased 20% and 12%, respectively.
- Foodservice sales increased 16% for the quarter and 14% year to date. Foodservice operating income increased 45% and 36%, respectively.
- Operating income included a $9.6 million benefit from the change in contingent consideration, primarily a $9.7 million reduction in the fair value of the Angelic Bakehouse earn-out liability.
- The after-tax benefit from the Angelic adjustment was approximately $7.4 million, or $0.27 per diluted share.
- Cash dividends were $0.65 per share in the quarter and $1.25 per share year to date, compared with $0.60 and $1.15 in the prior-year periods.
Cash Flow, Liquidity, Debt and Capital Resources
| Metric | Six Months Ended Dec. 31, 2018 | Six Months Ended Dec. 31, 2017 |
|---|---|---|
| Operating cash flow | $113.2 million | $84.0 million |
| Investing cash flow | $(86.5) million | $(15.6) million |
| Financing cash flow | $(38.0) million | $(32.7) million |
| Ending cash and equivalents | $194.5 million | $178.8 million |
- Cash used in investing activities included $58.2 million for acquisitions and $27.9 million for property additions.
- The company had no borrowings under its $150 million unsecured revolving credit facility; $5.1 million of standby letters of credit reduced availability. The facility expires in April 2021.
- At December 31, 2018, total assets were $875.5 million and shareholders’ equity was $704.8 million. Goodwill increased to $211.3 million from $168.0 million at June 30, 2018, primarily from the acquisitions.
- Management stated that operating cash flow and cash on hand should fund 2019 cash requirements and that it did not expect to borrow under the facility during 2019.
Material Changes Versus the Prior Comparable Period
- Net sales increased 9% for the quarter and 8% year to date, with Foodservice providing the majority of the growth.
- Gross margin was broadly stable, as volume, pricing, lean six sigma savings and operating efficiencies offset higher freight and warehousing costs and costs related to discontinuing the Marzetti Simple Harvest refrigerated dips line.
- Operating margin improved materially, partly because of the nonrecurring or potentially volatile contingent-consideration benefit.
- Net income growth was modest in the quarter because the prior-year period benefited from an $8.9 million one-time tax benefit related to the Tax Cuts and Jobs Act. Year-to-date net income increased 15%.
- SG&A increased 10% in the quarter and 7% year to date, reflecting acquisition-related transaction costs and higher severance costs.
- Cash acquisitions and increased capital spending substantially increased investing cash use.
Guidance, Outlook, Risks and Unusual Items
- Management projected fiscal 2019 capital expenditures of approximately $60 million to $80 million, including the Horse Cave, Kentucky frozen dinner roll capacity expansion, a dedicated research and development center, Angelic production investments and additional packaging and automation projects.
- The Horse Cave project is expected to be completed in mid-2020. The company expects to pay no more than approximately $40 million under the design/build agreement, plus approximately $22 million for related equipment.
- For the fiscal third quarter, management expects Retail benefit from Bantam sales, licensed shelf-stable products and prior pricing actions. The later Easter holiday is expected to shift some sales into the fiscal fourth quarter.
- Foodservice is expected to benefit from national-chain and distributor volume growth and Omni sales, but will begin lapping prior pricing increases and is not expected to receive further benefit from competitors’ temporary supply issues.
- Commodity and freight costs are projected to be slightly unfavorable. Integration and operational improvements at Omni are expected to create modest near-term financial headwinds.
- Key risks include acquisition integration and performance, freight and ingredient costs, pricing and competitive pressures, customer concentration and program losses, capacity constraints, product recalls, regulatory matters, labor availability, litigation and contingent pension obligations.
- The company recorded $16.4 million of Level 3 contingent consideration at December 31, 2018, including $9.0 million for Bantam and $7.4 million for Angelic. Bantam’s earn-out is based on future adjusted EBITDA through December 31, 2023 and has no stated minimum or maximum value.
- The company adopted the new revenue recognition standard on July 1, 2018 without a material cumulative adjustment. It expects the upcoming lease standard adoption in fiscal 2020 to significantly increase reported assets and liabilities but not materially affect earnings or cash flow.
- Management reported effective disclosure controls and no material changes to internal control over financial reporting. No material changes were reported to the risk factors in the 2018 Form 10-K.
Investor Verification Checklist
- Confirm issuer identity: the supplied filing is for Lancaster Colony Corporation, although the request metadata identifies Marzetti Co.
- Assess operating results excluding the $9.7 million Angelic contingent-consideration fair-value benefit and the prior-year one-time tax benefit.
- Verify the contribution and integration progress of Bantam and Omni, including the earn-out obligations and Omni’s interim supply agreement.
- Monitor the $60 million to $80 million capital-spending plan and the Horse Cave project’s approximately $62 million total stated commitment.
- Evaluate exposure to freight, commodity, packaging, labor and customer-pricing volatility, particularly in Foodservice.
- Review future cash requirements, dividend policy, share repurchases and unused revolving-credit capacity.