Seneca Foods Corporation (SENEB) 2010 Q3 法說會逐字稿

Welcome, ladies and gentlemen, to the quarterly earnings conference call.

At this time all participants are in a listen-only mode. Later we will conduct a question-and-answer session and instructions will follow at that time. (Operator Instructions) As a reminder this call is being recorded.

I would now like to turn the conference over to your speaker, Roland Breuning. Please go ahead.

Thank you. Hello and thank you for joining us today. Today Kraig Kayser, CEO and President, and I will be reviewing the results of the third quarter and for the first nine months of fiscal 2011. But before we do let me start first with the standard legal disclosures.

Information shared during this call may contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Because such statements are subject to risks and to uncertainties, our actual results may differ materially from those expressed or implied by such forward-looking statements. Investors are cautioned not to place undue reliance on such comments, which speak only as of the date of the statements that are being made.

Except for ongoing obligations to disclose material information as is required by the federal securities laws, the Company does not undertake any obligation to release publicly any revisions to any forward-looking statements to reflect events or circumstances after the date of this call or to reflect the occurrence of unanticipated events.

Some of the comments that we will make today refer to non-GAAP measures. The Company does not intend for this information to be used in isolation or as a substitute for other measures that are prepared in accordance with GAAP. I refer you to our third-quarter press release which contains reconciliations of GAAP to non-GAAP measures and to the Investor Information section of our website which is located at www.Senecafoods.com.

During our conversation we will be using phrases such as the full-year ended and year-to-date interchangeably. In addition, unless otherwise mentioned, references to current year in 2011 or to prior year in 2010 refer to the fiscal years that end on March 31, 2011 and 2010, respectively.

Now let me turn the call over to Kraig Kayser to talk about our business.

Thanks, Roland. Seneca reported third-quarter earnings of $11.5 million or $0.94 per diluted share during our third quarter versus $18.6 million or $1.52 per diluted share in last year's third quarter. Sales for the quarter of $446.3 million were down slightly from prior year's $447 million due to reduced selling prices partially offset by higher case sales.

Third-quarter results reflect the continued price wars in the market from last summer and fall's bumper crops as we promoted heavily to get inventories back in line. Nine-month's results show earnings of $19.5 million or $1.60 per diluted share on sales of $941.6 million, down from earnings of $42.1 million or $3.44 per diluted share on sales of $1 billion in last year's period.

Roland will review the financial performance in more detail later on, but I want to give you a little flavor for some of the main drivers for performance in the quarter and nine months.

As previously reported, Seneca has been heavily promoting this year to move the pack. The sales mix is a good indicator of this fact. For the third quarter selling prices reflected a decline of $16.7 million, while sales volumes were up $16 million.

This was the first quarter in a while where the lower selling prices were actually translating into higher case sales, which reflected the fact that retailers were finally passing on some of the savings associated with the lower selling prices on to consumers during the heavy holiday promotional period.

For the nine-month period sales are off $59 million over the prior year, of which 83% was attributable to reduced sales to two co-pack customers. The first being General Mills where we have our large production alliance for which we produce their Green Giant canned and some frozen product under contract, and the other being a large snack customer who discontinued a product we were making for them at our snack business in Washington state.

We are in the 16th year of our production alliance for General Mills and our business with them has been declining in recent years. While a very important business to Seneca, representing some 18% of revenues last year, our overall profitability exposure to declines in the business are somewhat modest due to the cost-plus nature of the relationship. Nevertheless, it is having a substantial impact on our reported top-line sales.

We look at the various commodities that we compete in. Our vegetable business remained profitable for the quarter, albeit at a lower level than previous years, but our fruit business remained in a loss position as every segment of our business was pressing to move excess product.

It has been a very challenging year in fruit as back-to-back large peach crops have saddled the industry with excess cases which are being sold at huge discounts to actual costs through conventional export and government bid programs. The industry has responded by reducing the amount of acres that they are planning on contracting this coming year which should improve the situation, but in the meantime the industry remains awash in product.

Some of the same issues occurring in the fruit business have also impacted the vegetable business over the past nine months. The good news, though, is a smaller-than-expected pack this fall combined with some large government bids. Our own inventory situation has significantly improved over the same time last year.

Now if you look at the balance sheet, it wouldn't necessarily appear that this is the case because inventories are reported to be essentially flat. However, the mix between finished goods and raw materials and supplies have changed as we are carrying more empty cans and steel and other raw materials and less finished goods. The higher on-hand raw materials is not necessarily a bad thing as there is significant inflationary pressures going on in our industry right now and the replacement costs for those raw materials are most certainly going to be higher.

In the quarter, the Company was also busy integrating the acquisition of the assets of Unilink LLC and the equity of Lebanon Valley Cold Storage, a Pennsylvania-based frozen vegetables packer that was doing approximately $65 million in annual sales. We acquired the business last August and converted the newly acquired business over to our systems during the third quarter.

This was not without some headaches as the holiday selling season and the unfamiliarity with the new systems have created some service issues that we are continuing to work through. Those issues, combined with a very competitive pricing environment, have left the frozen business with losses as well in the quarter.

You will note that the Company reported non-operating earnings for the quarter of $720,000, of which $632,000 was a reflection of the price we paid for this business being less than the appraised value of the real assets of the acquisition. As the price was lower than the appraised value, we were required under new accounting standards to report that difference as income.

Once again, it's a reflection of the Company's long-standing philosophy to not pay more than the tangible value for assets, which is reflected by the fact that we have no goodwill or intangibles on our books.

As we head into our fourth quarter we are seeing hopeful signs of improvement for the coming fiscal year, fiscal 2012, although the current fiercely competitive environment remains unabated and will continue through the fourth quarter. The fact that inventory levels are improving and, in some cases, even a little shorter than average means that there is potential for an improved selling environment.

Coupled with what is surely to be significantly higher overall costs next year due to the inflationary pressures from inputs like produce and steel mean that the Company will have to reflect these higher costs similar to what happened in calendar year 2008, which ultimately led to two of the best performing years in the Company's history.

Now Rowland will review the financial performance in further detail.

Thank you, Kraig. As Kraig mentioned, third-quarter fiscal sales were $446.3 million versus $447 million a year ago. While on a net basis sales were essentially flat year-over-year, sales volume increased by $16 million while selling price and sales mix decreased by $16.7 million.

Sales to General Mills decreased by $11.9 million in third quarter 2011 versus prior year, and consisted of a $17.9 million volume decrease and a $6 million price mix increase. The General Mills volume decrease was attributable to a smaller corn pack than prior year, which was partially offset by increased sales of other products, while the price mix increase was due to increased product costs that are charged to General Mills under our cost-plus agreement.

Excluding General Mills, third-quarter volume increased $33.8 million from prior year due to increased canned vegetables, frozen vegetables, and fruit unit sales, while third-quarter price mix decreased by $22.7 million from prior year due primarily to decreased canned vegetables pricing. The increase in frozen product sales was in part due to the addition of our Lebanon operations that were acquired in August 2010. Sales to the USDA increased by $5.3 million from third quarter 2010 due to increased volume and more favorable pricing.

On a year-to-date basis fiscal 2011 sales decreased by $59.1 million from prior year, attributable to an $11.1 million increase -- decrease, rather, in volume and a $48 million decrease in selling, price, and sales mix. Excluding our General Mills and snack operations, year-to-date sales volume increased from -- by $43.2 million from prior year due to increases in frozen, canned vegetable, and canned fruit products while year-to-date selling price and sales mix decreased by $53.2 million.

Sales to General Mills decreased by $39.7 million due to a $[43] million volume decrease from lower corn and pea packs, offset in part by a $3.9 million sales price increase attributable to higher product costs charged under our cost-plus agreement. Snack sales decreased by $10.6 million from prior year due to a loss of a cold-pack customer.

The increase in frozen product sales was in part due to the addition of our Lebanon acquisition. And year-to-date sales to USDA increased by $5.3 million from the prior year due to increased volume, but on a year-to-date basis less favorable pricing.

During third quarter fiscal 2011 trade promotion spending moderated somewhat from the significant increases experienced in the first half of the year, although we still experienced a $6.7 million or 33.9% increase over third quarter fiscal 2010 spend. On a year-to-date basis, trade promotions, which we deduct from sales when we report net sales, increased by $24.7 million or 60% from prior year. The pricing environment continues to be competitive.

We continue to experience lower LIFO charges in fiscal 2011 versus prior year, reflecting a decreasing rate of increase in our input costs, and this is helping our gross margins. In third quarter 2011 we had a LIFO credit of $2.1 million versus a LIFO charge of $4 million in the third quarter of fiscal 2010. For the current year-to-date we have recorded a LIFO credit of $6.9 million versus a $13.4 million LIFO charge during the first three quarters of fiscal 2010.

The reduced selling prices previously discussed caused our third-quarter fiscal 2011 gross margin to decrease to 7.7% from 10.9% a year ago and year-to-date gross margin to decrease to 8.4% from 12.3% last year. On a FIFO basis our third-quarter gross margin decreased from 11.8% in fiscal 2010 to 7.3% in fiscal 2011, while our nine-month gross margin decreased from 13.7% in fiscal 2011 to 7.6% in fiscal 2010.

Selling expenses as a percent of net sales increased from 2.1% in third quarter fiscal 2010 to 2.3% in the prior year. This was due to a higher mix of broker sales. For the year-to-date selling expenses increased from 2.7% in fiscal 2010 to 2.8% in fiscal 2011 for the same reason.

General and administrative expenses, as a percentage of sales, decreased from 1.5% in third quarter fiscal 2010 to 1.3% in fiscal 2011 and from 2.2% for the year-to-date fiscal 2010 to 2.1% for the year-to-date 2011 due to reduced employee compensation costs. Overall, SG&A expenses remained flat at 3.6% of net sales during the third quarter and flat at 4.9% for the year-to-date of 2011 and year-to-date 2010.

Interest expense increased by $0.4 million in third quarter fiscal 2011 from prior year due to a $24.1 million increase in average borrowings on the Company's revolving line of credit at higher effective interest rates. It should be pointed out that during that time as we acquired the Lebanon company we incurred that additional cost.

For the year-to-date interest expense decreased by $0.6 million due to lower interest rates, although our average line of credit borrowings increased by $33.5 million. As previously discussed, the average -- the increased average line of credit borrowings is attributable to using the line of credit to fund a $32.1 million debt retirement in September 2009.

As has previously been discussed, the Company acquired Lebanon Valley Cold Storage LP and the assets of Unilink LLC in August 2010. The Company recorded $0.6 million gain in the third quarter of fiscal 2011 to recognize the excess of the fair market value of acquired assets over the applicable purchase price. This gain was recorded in the other operating income section of the income statement.

EBITDA decreased from $37.8 million in third-quarter fiscal 2010 to $24.8 million in third-quarter fiscal 2011 and from $90 million in the first three -- I am sorry, the first nine months of fiscal 2010 to $49.8 million in the first nine months of fiscal 2011 due to the Company's decreased gross margins.

On a FIFO basis, EBITDA decreased from $41.8 million in the third quarter of fiscal 2010 to $22.9 million in third quarter fiscal 2011 and from a $103.4 million in the first nine months of fiscal 2010 to $42.9 million for the first nine months of fiscal 2011. Again, reflecting the $6 million decreased LIFO charge in third quarter fiscal 2011 versus last year and a $20.3 million reduction in LIFO charge for the first nine months versus a year ago.

The Company's third-quarter effective tax rate decreased from 38% in fiscal 2010 to 31.8% in fiscal 2011 due to decreased FIN 48 charges in the current year. On a year-to-date basis our effective tax rate decreased from 37% in fiscal 2010 to 27.1% in fiscal 2011 due to favorable settlements of IRS audits for our 2006, 2007, and 2008 fiscal years.

LIFO basic and diluted earnings per share were $0.94 and $0.94 in the third quarter of fiscal 2011 versus $1.53 and $1.52, respectively, in the third quarter of fiscal 2010. For the nine-month periods LIFO basic and diluted earnings per share were $1.61 and $1.60, respectively, compared to $3.47 and $3.44, respectively, in fiscal 2010.

Our third-quarter fiscal 2011 LIFO credit of $2.1 million increased diluted earnings per share by $0.11, whereas the third quarter fiscal 2010 LIFO charge of $4 million diluted EPS by a $0.21. It reduced diluted earnings per share by $0.21. For the nine-month periods the fiscal 2011 LIFO credit of $6.9 million increased diluted EPS by $0.37, while the fiscal 2010 LIFO charge of $13.4 million reduced diluted EPS by $0.72.

On a FIFO basis, third-quarter diluted EPS was $0.83 this quarter versus $1.73 last quarter and year-to-date EPS was $1.23 this year compared to $4.16 a year ago. Free cash flow, which we define as cash from operations less CapEx, was $11.4 million for the third quarter of fiscal 2011 versus negative $26.1 million for third-quarter fiscal 2010.

The $37.5 million third-quarter improvement versus prior year is primarily due to a $30.2 million reduction in cash used for inventory, net of a $10.3 million increase attributable to the Lebanon acquisition. This was due to the vegetable pack being less in fiscal 2011 versus the prior year.

On a year-to-date basis free cash flow was negative $49.1 million in fiscal 2011 versus negative $70.5 million in fiscal 2010. Again, primarily due to a reduction in cash used for inventory net of the acquisition. Inventory, as of third quarter fiscal 2011, increased by $0.4 million versus prior year which included a $16.6 million increase attributable to the Lebanon operations that were acquired in August.

Finished goods, net of off-season, decreased by $33.1 million, primarily due to a reduced vegetable pack which has helped right-size our vegetable inventories. Raw materials and supplies increased by $24.9 million due primarily to increased can and raw steel quantities, and work in process increased by about $9 million.

CapEx was $5.9 million in third quarter fiscal 2011 versus $4.1 million in third quarter fiscal 2010. On a year-to-date basis CapEx is $15.5 million in fiscal 2011 versus $14.6 million in fiscal 2010.

During the second quarter of fiscal 2011, the Company received a $50 million advance from General Mills against the corn pack that was being produced for General Mills. The advance, which was recorded as deferred revenue on the second-quarter balance sheet, was applied against sales proceeds received from General Mills for its corn purchase in October 2011 and was recognized as revenue in the third quarter fiscal 2011, which is consistent with the Company's revenue recognition policy for bill and hold sales.

The Company has several projects underway that will ultimately be financed through operating leases. During the third quarter of fiscal 2011 the Company entered into some interim lease notes, which financed down payments for various equipment related to these projects.

At the end of the third quarter some of the interim notes had not yet been converted into operating leases because the equipment was either not delivered or not fully installed. These notes, which totaled about $4.2 million at the end of the quarter, are included as notes payable on the Company's balance sheet and they are expected to be substantially converted into operating leases before the end of the fiscal 2011.

Now I would like to turn it back to Kraig for concluding comments.

Thanks, Roland. In conclusion, case sales were strong for the third quarter as the predicted promotional activity in the holiday selling season came to pass. Combined with a smaller than expected pack, our inventory issues are showing signs of improvement. Profits will remain a challenge between now and new pack.

The Company remains in an excellent position strategically and financially to benefit from the longer-term emphasis on eating more fruits and vegetables as we weather through the normal ups and downs of our business. Now Roland and I will be happy to answer any questions.

(Operator Instructions) Bryan Spillane.

Good morning. A couple of questions. First, just looking at the gross margin, gross margin in the third quarter sequentially from the second quarter, the improvement there sequentially is more a reflection of less promotional activities? Is that the way that we should sort of look at it?

I am just trying to -- because I think my gross margin expectation for the quarter was a little bit lower. I am just trying to figure out sequentially what the difference was.

I think that is reasonable. If we look at our gross margins and specifically to your point, Brian, with regard to trade promotions, our trade spend this quarter was about 34%. In dollar terms that is about $27.3 million.

A quarter ago it was 65% of gross sales and that is about just under $21 million, so there is a reasonably large increase in the quarter in the actual spend. And I think that does, obviously, translate into some decreased margins.

Okay. And then in terms of your finished good inventories, up until -- so it sounds to me, and see if this is right, on the veg side you have moved a lot of your excess inventory so the discounting you needed to do in veg in order to make room for this most recent harvest you have basically done what you needed to do in order to move that.

On fruit, though, you still may need to do some more deep discounting in order to make room for next year's pack. Is that right?

That is absolutely correct, Bryan. Keep in mind, however, that some portion of our vegetable business is annual bids and some of those annual bids were set at prices that we are going to have to live with until they get reset next year. About 40% of our overall private-label retail business is annual bid business, so there is going to be some drag relating to what went on last year that will drag out into the future.

But overall inventories, with a few exceptions in vegetables, are in much better shape than we were last year at this time. And the fruit is -- no question the issues relating to fruit that existed last year continue to remain this year.

So if I start thinking about -- there is a cycle here and you have been in the trough in terms of profitability. In terms of moving back towards a peak, maybe a little longer runway to get to the peak because you have got the residual impact from some of the contracts you had to make on veg and you still have some ongoing overhang in fruit. Is that a good way to think about it?

I think that is reasonable. Just remember when we talk about peaks, those were some pretty darn good years we had so I don't think you need to set that as the bar for all-time future performances. Our business is one where every year we are dealing with Mother Nature. We are doing our very best to move the pack and maximize profits, but those circumstances are going to be a challenge, at least in the near term, to duplicate.

One thing to also keep in mind, everybody knows there is inflation coming. Well, inflation in our business translates to LIFO charges which could be quite significant next year. We are in the process of negotiating produce contracts over the next 30 to 60 days with our farmer partners and we are going to have increases across the board on other raw materials pretty much.

So the LIFO credits that we have been having this year, in all likelihood, will revert to some, probably some pretty substantial LIFO charges which we are not ready to quantify yet.

Understood, understood. Kraig, on just the retail end of the business, you mentioned in the prepared remarks that you have begun to see some of the discounting at retail sort of inducing the volume.

I was under the understanding that Wal-Mart had also changed shelf sets to sort of restore what they had done previously and maybe adding a little bit more -- dedicating a little bit more shelf space to canned product. Can you just talk a little bit about what -- is that true? And just generally any changes at retail relative to the sort of the emphasis that retailers have put on canned veg and fruit, other than just price promotion.

Well, I think the price promotion is the primary driver, and we saw a lot of activity in the holiday season, both Thanksgiving and Christmas. And not just ourselves. You look at the circular ads that were coming out every week, our competitors were also very aggressive in a lot of promotional activity and I think that moved the bar a little bit.

Now if you want to talk about things outside of that, the Wal-Mart reset I think is still a work in progress. I haven't -- there isn't any discernible change that I can tell in terms of movement from the business that we have been doing with them. But I do know that they have gone through that reset.

And I think -- also if you look at alternative formats, they have also had strong promotional activity going on and sales were very good in the holiday periods. The holiday periods are now behind us and generally the first quarter is a little quieter as a lot of consumers have stocked their cupboards up with product due to the heavy promotions.

And then, Kraig, you have got a competitor that is going to be bought by a private equity firm. Any comments on -- that is a business that has been owned by private equity firms in the past. In the past in this similar situation has there been any change in the way that competitor has behaved owned by a private owner versus a public owner?

Well, it's hard to predict what a new management team -- I am not exactly sure what will happen with Del Monte. I just know that they are good competitors and they always have been. They have got an excellent brand name, strong positioning in the marketplace, and I wouldn't expect that life will get any easier for us because they have new owners.

Okay. And then, Roland, just with cost, with input costs or cost inflation on your inputs likely to be moving up over the balance of the year, will you have to increase borrowings to build inventory for next year's pack?

It's potential that we could. I think what -- as we look at next year and look back to, let's say, 2008 when there was also significant pressures on our commodity inputs, in that environment, where it was a very broadly based series of inflation, we were able to increase our selling prices and generate cash flow really in advance of some of the cash outlays that related to that.

So while we are certainly looking at that in our model, there would be perhaps an expectation of some replay of that happening. But on a net basis there will likely be some impact on our peak borrowings.

Okay, great. I will leave it there. Thank you, guys.

(Operator Instructions) Tony Gikas.

Good morning, guys. A couple questions. Kraig, maybe you could give us a little bit of an update on the final harvest as it played out through the December quarter, specifically corn, and really where it came in at the end of the harvest period.

Also, what can you do with your farm contracts? As you are going through those right now what your farming partners, what can you do within those contracts to really improve profitability here for the next year? And then I have a couple follow-ups.

Okay. Well, with respect to the final harvest, I think I mentioned we had a shorter-than-expected pack season, both sweat peas, which is the first major crop to come into our plants due to heavy rains, and shorter than expected corn pack, primarily due to bunching and we some hot weather during the season. A lot of it coming due all at the same time and we had to pass some acres as a result.

The green beans and other crops pretty much came in on budget. Fruit came in above budget, as I had mentioned in the call, and so it's a mixed bag. Vegetables, overall, I think from a final harvest perspective, shorter than expected pack actually helped our overall inventory situation combined with the heavy sales in this third quarter.

What can we do to improve on our profit situation with respect to our grower contracts? Our relationship with our growers is one where we have to be competitive with their alternative crops and the alternative crops depends on what part of the country we are in. But by and large, in the upper Midwest it's soybeans and field corn and to some extent sugar beets.

All those markets have been pretty strong, so consequently as we negotiate this year with our farmer partners we are going to have some recognition that we have to be competitive with those alternative crops. And our produce pricing will, in fact, be increasing fairly substantially.

Okay. Two more follow-ups here. I guess we have seen commodity costs increasing. It's going to be even perhaps more so in calendar 2011. How do you feel about putting price through at retail? Why hasn't there been more of it, I guess would be one of my questions.

And then the second part of it, any update on your market share data for canned veggies and fruit and where you stood at the end of calendar 2010?

Well, looking backwards on why hasn't more pricing gone through at retail, frankly, this third quarter was still a quarter where we were dealing with the heavy, heavy inventories that were on our books. Promotional activity takes time to schedule and so if you look back from January 1, which was the end of the quarter, backwards, we were still in the full mode to try to move excess inventories with inventories in balance.

I have the expectation that we should begin to see some improvement. But in the third quarter the industry and Seneca were still very, very, very busy competing to try to move excess packs.

Market share data, I think private -- I don't have it in front of me, Tony, but I think private-label has kind of been holding its own share over the three-month period. I don't think that we had any substantial gains during that period up against brands, but it has not lost any ground either.

Has your overall market share held up on total for canned veggies and canned fruits?

I would say yes.

Okay. Then the General Mills business looks like it's going to be down $50-ish million for the fiscal year. What type of a decline do we see in the next fiscal year to that business as well?

It very much depends on what Mother Nature brings us, but we would expect to see declines based on what we have been told by them. But I am not prepared to quantify that.

Okay. You had some reduced employee expenses. Is that really -- were there headcount changes or is that primarily just less comp as a result of less profitability for the business?

We did have some headcount changes. I wouldn't call it dramatic. In reality, given with the way the year seems to be shaping up, we have not expected there to be bonus payments and so it really is compensation related.

Okay. Thank you, guys.

I am showing no other questions in the queue, gentlemen.

Thank you very much, everyone.

Thank you.

Thank you, ladies and gentlemen, for joining today's conference. That concludes the program. You may now disconnect. Have a great day.