Lancaster Colony Corp
NASDAQ:LANC
If you don’t study any companies, you have the same success buying stocks as you do in a poker game if you bet without looking at your cards.
Utilize notes to systematically review your investment decisions. By reflecting on past outcomes, you can discern effective strategies and identify those that underperformed. This continuous feedback loop enables you to adapt and refine your approach, optimizing for future success.
Each note serves as a learning point, offering insights into your decision-making processes. Over time, you'll accumulate a personalized database of knowledge, enhancing your ability to make informed decisions quickly and effectively.
With a comprehensive record of your investment history at your fingertips, you can compare current opportunities against past experiences. This not only bolsters your confidence but also ensures that each decision is grounded in a well-documented rationale.
Do you really want to delete this note?
This action cannot be undone.
| 52 Week Range |
161.88
207.63
|
| Price Target |
|
We'll email you a reminder when the closing price reaches USD.
Choose the stock you wish to monitor with a price alert.
This alert will be permanently deleted.
Lancaster Colony Corp
You don't have any saved screeners yet
Good morning. My name is Denise and I'll be your conference call facilitator today. At this time, I'd like to welcome everyone to the Lancaster Colony Corporation's Fiscal Year 2018 Fourth Quarter Conference Call. Conducting today's call will be Dave Ciesinski, President and CEO; and Doug Fell, Vice President and CFO. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session period. [Operator Instructions] Thank you.
And now to begin the conference call, here is Dale Ganobsik, Vice President of Investor Relations and Treasurer for Lancaster Colony Corporation.
Thank you, Denise. Good morning everyone and thank you for joining us today for Lancaster Colony's fiscal year 2018 fourth quarter conference call. Let me remind everyone before we begin that our discussion this morning may include forward-looking statements, which are subject to the Safe Harbor Provisions of the Private Securities Litigation Reform Act of 1995.
These statements are subject to a number of risks and uncertainties that could cause actual results to differ materially, and the company undertakes no obligation to update these statements based upon subsequent events. A detailed discussion of these risks and uncertainties is contained in the company's filings with the SEC. Also note that the audio replay of this call will be archived and available on our company's website, lancastercolony.com, later this afternoon.
With that said, I’ll now turn the call over to Dave, Lancaster Colony's President and CEO, Dave Ciesinski. Dave?
Thanks Dale and good morning everyone. It's a pleasure to be here with you today as we review our fourth quarter results for FY 2018. Doug and I will provide comments on the quarter, the year and the fiscal year 2019 outlook, following that we’ll be happy to respond to any of your questions.
For the fourth quarter consolidated net sales increased 6.3% to $308.2 million versus $289.9 million last year. Retail net sales increased 1.7% to $156.8 million driven by refrigerated dressings and dips along with shelf-stable dressings and sauces sold under licenses. Frozen bread was down for the quarter as influenced by the impact of the shift in the Easter Holiday from our fiscal fourth quarter last year to our fiscal third quarter this year.
On the pricing front we continue to make progress implementing price increases with our retail customers to help offset higher commodity cost and freight cost. We also reduced the level of trade spending to optimize those cost through our investment in category management tools.
Foodservice net sales grew a strong 11.6% to $151.4 million driven by segment-wide sales volume increases, [Audio Gap] with our national chain customers. Pricing actions also helped to offset higher freight and commodity costs.
Consolidated gross [Audio Gap] million as the favorable influences from the increased [Audio Gap] spending, reduced coupon expenses and cost savings realized from our lean six sigma program overcame the impact of higher freight and commodity costs.
SG&A expenses increased $3.5 million as the prior-year quarter included a one-time pre-tax benefit of $1.4 million from the full settlement of a class-action lawsuit. The higher level of SG&A cost also reflected higher expenditure for retail consumer promotions.
Consolidated operating income was essentially flat at $42.9 million while consolidated operating margin declined 80 basis points due to the factors referenced above, including a less favorable sales mix as sales growth in the Foodservice segment outpaced that of Retail. Retail segment operating margin declined from 20.5% to 19.1%, [Audio Gap] influenced by the $1.4 million one-time benefit in last year’s fiscal fourth quarter from the lawsuit. Other factors resulting in the reduced Retail segment operating margin were the higher costs in the quarter for freight and commodities in addition to the increased spend in retail consumer promotions.
The Foodservice segment operating margin improved from 9.9% to 10.6% largely due to price recovery from our national account and pricing implemented in branded Foodservice. Net income was $32.4 million, or $1.18 per diluted share, compared to $28.5 million, or $1.04 per diluted share last year. The regular quarterly cash dividend paid on June 29, 2018 was maintained at the higher amount of $0.60 per share set in November 2017.
Turning our attention to retail sell-through data from IRI for the 13 weeks ending July 1, 2018 we maintained our share leadership position in all of our six categories. During the quarter, we were able to increase our share in two out of the six categories while we saw a modest pull back in the reminder, due to our targeted pricing and trade reduction activities. For the full year consolidated net sales increased 1.8% to a record $1.2 billion.
The Retail segment net sales increased 1.4% to $650.2 million driven by increased sales volume for shelf-stable dressings and sauces, the incremental sales from Angelic Bakehouse, pricing actions, reduced trade spending and lower coupon expenses. The Foodservice segment net sales grew 2.2% to $572 million. After a very challenging first half of the fiscal year, segment sales improved significantly in the second half, both with inflationary pricing and volume gains contributing to this growth.
Consolidated operating income decreased $2.6 million to $172 million from $174.7 million last year excluding the pre-tax charge of $17.6 million in the prior-year, resulting from the company’s withdrawal from an underfunded multiemployer pension plan, operating income declined $20.2 million or 10.5%.
Increased commodity costs particularly eggs [Audio Gap] the primary causes for the drop in operating income. These were partially offset by costs savings realized from the company's lean six sigma program and pricing action. At the segment level, driven by the same factors that I just mentioned, Retail operating margin [Audio Gap] while the Foodservice operating margin declined [Audio Gap]. Net income totaled $135.3 million or $4.92 per diluted share versus the prior year amount of $115.3 million or $4.20 per diluted share.
[Audio Gap] the lower federal income tax rate [Audio Gap] net income amount was unfavorably impacted by the costs resulting from the company's withdrawal from the underfunded multiemployer pension plan of approximately $11.5 million or $0.42 per share. The regular cash dividend was also increased during the year for the 55th consecutive time.
With that, I'd now like to turn it over to Doug to make some comments on the balance sheet [Audio Gap].
Thank you, Dave. Overall, our balance sheet remained strong. I will make a few brief comments on the more meaningful changes in our balance sheet since last year. From a high level perspective nearly all of the increase in our cash balances of $63 million since last year can be summarized as follows.
Cash provided by operating activities of $161 million, offset by regular dividends of $65 million, and property additions of $31 million. Accounts receivable balances came in line with sales volumes and our expectations. Consistent with past quarters, [Audio Gap] increase in inventory reflects the impact of several items including increased sales volumes, higher input cost from commodities, balancing of production within our plans for seasonal inventory builds and some adjustments to our days of forward coverage to maintain high levels of customer service.
As I mentioned, fiscal year-to-date cash, expenditures for property additions totaled $31million. This is in line with expectations. Consistent with our past communications, in addition to the expansion project for our Angelic Bakehouse facility this year, the largest amounts were spent on new processing and automation equipment to accommodate growth and enhanced productivity.
Looking ahead, at the present time we anticipate capital expenditures to be in the range of $60 million to $80 million for fiscal 2019 and in general we will focus on projects to increase capacity and productivity. [Audio Gap] for 2019 is to expand production capacity to meet increased demand for our Sister Schubert products. This project is expected to start this fall with a projected completion date in fiscal 2020. Other notable projects to be completed in fiscal 2019 involve a dedicated innovation center and packaging capacity for our Retail dressings.
Depreciation and amortization expense totaled $27 million for fiscal 2018 [Audio Gap] level around $30 million for fiscal 2019. As we conveyed last quarter, the increase in our accounts payable since June [Audio Gap] emphasis by our procurement team to extend payment terms with our vendors in conjunction with our ongoing lean six sigma efforts.
With respect to our balance sheet capitalization, not much has changed since our last commentary. We continue to have no debt, over 650 million in total shareholder’s equity and over $206 million in cash and equivalents. Borrowing capacity under our credit facility remains at nearly $150 million.
Finally, and broadly speaking, as reported in our past quarter earnings release, our income tax provision for fiscal 2018 was favorably impacted by the Tax Cuts and Jobs Act. Our blended effective tax rate for fourth quarter was estimated to be 28.5%, yet our actual tax rate was 26%. The favorable difference of 250 basis points is largely due to two discrete items of roughly equal size.
First, the continued refinement of the estimated impact of the Tax Act on our deferred taxes; and second, the impact of the new accounting guidance on the tax treatment of employees stock option exercises. Looking forward at this time we continue to estimate our effective tax rate for fiscal 2019 to be approximately 24%.
Thanks for your participation with us this morning. I will now turn the call back over to Dave for our concluding comments. Dave?
Thanks Doug. Looking ahead to fiscal year 2019 retail sales will benefit from new product introductions and including Marzetti Simple Harvest plant-based dips, our fresh lineup of 60-calorie Flatout wraps and new Angelic Bakehouse sprouted grain wraps that are made with super foods such as Kale & Spinach, Beet and Sweet Potatoes. In addition, our Retail segment expects to build upon the recent rollout of the new Olive Garden Parmesan Ranch dressing flavor and implement a follow-on program to our recent successful retail test of Buffalo Wild Wings.
In the Foodservice segment, we expect to continue to strengthen our existing customer base and pursue new opportunities for profitable growth through our culinary expertise and noted reputation for custom-formulated products. Based on our current assessment, commodity costs are projected to remain unfavorable in fiscal year 2019, although to a lesser extent than we experienced in fiscal year 2018.
Freight costs are expected to persist as a headwind through the first half of 2019. Higher pricing in both Retail and Foodservice segments will help to offset these increased costs. In addition, our supply chain team will remain focused on cost-saving initiatives and opportunities throughout the coming year.
Finally, I’d like to expand upon Doug's reference to our forecasted FY '19 capital expenditures of $60 million to $80 million. This past May, our Board of Directors approved three significant strategic projects that will drive long-term benefits to our business but elevate our short-term capital spending. The first project is a material capacity expansion for our Sister Schubert business. This project will not only help the continued growth of our retail business, but also position us to meet the increasing demand from one of our key Foodservice customers.
The second strategic project is the new high-speed bottling line that will be installed at our dressing and sauce facility in Columbus Ohio. This project will enable us to in-source the Retail dressing volume that's currently co-packed and also provide us with added capacity for future growth.
The third strategic project is the new innovation center that's planned for construction in the Columbus area. This facility will enable us to bring Retail and Foodservice R&D teams and our quality team all together in one central location to more effectively collaborate within our organization, but also with our retail and Foodservice partners. We believe that innovation is the key to our success.
We expect the innovation center and the bottling line projects to be completed in fiscal year 2019 and as Doug mentioned we anticipate the Sister Schubert expansion project to be completed in fiscal year 2020, most likely at the back half.
Excluding these three strategic projects we expect our fiscal year 2019 capital spending to be essentially in line with that of fiscal year 2018.
That concludes our prepared remarks for today and we'd be happy to take any of your questions.
[Operator Instructions] Your first question comes from Michael Gallo with CL King. Your line is open.
Hi good morning.
Good morning, Mike.
Good morning, Mike.
Just a couple of questions. I guess just to delve in a little bit on your margin commentary, obviously fiscal 2018 was a difficult year from a margin perspective you had higher commodity and labor as well as logistics costs, you had obviously the issues related to the fire which impacted some of your retail volumes as you went through the year. It would seem that at least the commentary you have here suggests that there's going to be some continued headwinds in fiscal 2020.
You do have better - I think you'll have better price realization it would seem. So I guess just sort of boiling it down do you expect that you'll be able to materially improve your gross margins in 2020 or will it be just a continued transition where you'll continue to have to take costs out and get pricing just to kind of hold the line or slightly improve margin? Thanks.
Sure, so Mike great question and why don't I dive in for you. So if you think about it we've been, we in the industry have been talking about two forms of inflation coming in, first that the raw material and packaging and freight. As we think about the sequencing of fiscal year 2018 which we just ended in fiscal year 2019 the first thing we're seeing is a bit of a step down in commodity inflation as context. We expect to see one more quarter of just pure commodity inflation principally driven by eggs and then we think that it will continue to be inflationary, but at a more modest pace through the remainder of the year.
Freight, we expect to be a headwind for the entire first half. If you remember the hurricanes hit at the very end of Q1 beginning of Q2 and then we saw subsequent and significant step up in those costs due to the new Department of Transportation rules. So we're going to see freight as a headwind through the first half and then plateau thereafter. So if you then take maybe three big steps back to frame it in another context, probably about three quarters ago we began aggressively tracking what we call, PNOC, pricing net of commodities and this is the first quarter where we're seeing positive PNOC in both segments.
What we're doing is we're offsetting the costs in the absolute sense, but we haven’t been able to get enough yet to necessarily hold margins. So how do we think about this then on a go forward basis? The first thing that I would share with you is that we're going to see probably a tougher first half principally because of freight.
Remember the freight for us is up in the gross margin category and one quarter that's tougher, the first quarter, also driven by commodities and then we're going to see - what we expect to see is more improvement thereafter. If you look at the entire fiscal year, we would expect to see flat to modest improvement based on what we currently see today.
In terms of the year overall though would you expect you would be able to improve gross profit…?
Yes, and that's what I meant Mike, I'm sorry if I wasn’t clear. We would expect for the full year to see modest improvement.
Okay, great and then just a follow up in terms of just, the step up in capital expenditures, I think I heard you say the Sister Schubert plant wouldn't be complete until sometime in 2020. So should we expect this kind of stepped up level of capital expenditures to go for the next two fiscal years or would you expect that to kind of level off next year or perhaps not as high as ’19 but say somewhat elevated? Thanks.
Mike, what I would tell you is, right now what we have very clear line of sight to is what we've outlined, we're continuing to evaluate projects. And we went through the three that we're focused on the most material of which is the capacity expansion for Sister Schubert. That project is going to be probably more heavily weighted towards fiscal year ’19 with some cost incurred in ’20.
The other two are more modest and they're going to be completed in this upcoming fiscal year ’19. So the best we can tell you now is this is what we have a clear line of sight to, as we continue to evaluate other opportunities with the Board and especially when it takes our spending at an elevated level you can count on us to come back to you and sort of take it through what we're thinking.
Thank you.
Absolutely.
Your next question comes from Jason Rodgers with Great Lakes Review. Your line is open.
Yes. Hello guys.
Hi Jason, good morning.
Good morning, Jason.
Good morning. I just wanted to follow up with the whole commodity cost question. I mean just looking at soybean oil it's come down dramatically and I was just wondering why you wouldn’t see some type of tailwind in fiscal ’19 from that?
That's a great question. So we are seeing soybean come down that's been a class that's been favorably impacted and what we're seeing on the flip side though it's for us eggs are a really large commodity category. We buy both whole eggs and yolks and they remain elevated versus prior year, so that would be one. Packaging cost, liner board, corrugate and resin all remain elevated. And honestly for us transportation cost is also included in that and that's a big number.
If you think about our total business this past year, all in we probably looked at somewhere in the range of 5% of gross inflation across the business and what we're seeing is that inflation is going to remain elevated albeit at a more modest rate into fiscal year ’19. That the trade, the stuff that's going on externally has helped us with soybean, but it hasn't seemed to give us any relief in the other classes.
Yes and one thing I'll add to that Jason. This is Dale, is that the basis cost and I think today is one of the transportation costs in soybean oil is really cut into what you would see just on the spot market for that, so just want to make you mindful of that.
All right and a very nice increase in the Foodservice segment for the quarter, how much of that was due to one-time programs versus just general better or better environment for the restaurant chains?
A fair amount of that was just from a couple of things, it was just a better overall restaurant environment, and we've been able to pick up some new accounts. We did benefit from an elevated level of LTOs but that wasn’t a big side. If we sort of had to rank them for you I would say, first and foremost would have been the improved external environment and improvements within our business that were volume driven, the second would have been pricing related associated with commodity inflation that we're finally getting through and then the third component would have been driven by LTO activity.
All right and if I could just squeeze one more in, would you happen to have what the volume increases were for the quarter in total and by segment?
I don't know. We don't necessarily break it out by segment, but I can tell you that the overall volume increase was about two points.
All right, thanks very much.
Thanks Jason.
Your next question comes from Brian Holland with Consumer Edge Research. Your line is open.
Thanks, good morning.
Good morning Brian.
Good morning. Thanks, if I could ask first about maybe the reconciliation between the consumption trends that we're seeing in IRI versus the reported in the Retail segment, not the first time this has happened, but there is a pretty meaningful gap between reported and track sales.
Should we attribute that to Blue Buffalo sell-in or the extent to which Blue Buffalo sales are occurring in non tracked channels I'm just wondering if you're seeing that disconnect and if that's what you would attribute it to?
And then maybe just as a follow on to that, if you could give us some sense about the scope of where that Blue Buffalo rollout is today and how we think about - where that - what that looks like over the next 12 months?
Got it Brian. I think you're seeing Blue Buffalo but knowing you like I do I think what you mean is Buffalo Wild Wings in our case is that correct?
Yes, pardon me. Yes.
You and I were on the same frequency. I just want to make sure everybody else was as well. So going right to it that was in fact one component of it. Why don’t I talk about what we've done to date? What we've run has been a test within Costco that went extremely well. What we have planned to do is to expand that into all the club channel and into retail on a limited basis as well and it's going to extend across the year. you can expect to see the product really start to hit in the fall, sort of think the latter part of football season and go hard through football season into basketball season in March Madness and then we'll sit down with our partners at Buffalo Wild Wings and really evaluate things from that point forward.
So it was a contributor to the quarter albeit a bit of a modest one. The other contributor that we had that was material was the continued selling of our Olive Garden Parmesan Ranch. You had a specific question about how do we reconcile against what you see in the measured channels and what you're seeing otherwise, I think probably what I would point to is if you think about that 1.7% that was partially also driven or more than partially it was driven by pricing and some of the other net price realization tools.
In our case what we are doing given that the fight that we in the industry have against inflation is we are going back looking at category by category and saying where do we have rented, share and when we have share that we own, where does that make sense for us to pull back on trade spending where we think we can get justifiable price realization and work our way out up a profit curve and where does it not. So in this case in Retail it was not a volume led story as much as it was a pricing led story.
Thanks, that's helpful context. Maybe just a quick follow on, on the pricing side, so I think the reported results and maybe a little bit with respect to your outlook to ’19, it paints a more favorable or optimistic view of pricing, then maybe your commentary in Q3 which was quite, you quite candidly sounded like there was still some concern about whether you'd get that.
So I'm just curious if you could maybe walk us through, what you're seeing - what sort of happened here over the last quarter that sort of, I mean again this is my interpretation that it looks like this is coming in more at the high end of your expectations so maybe what sort of transpired to get there?
Yes, absolutely. So we'll break in into the two segments. First of all, I think we probably started mention in late Q2 and Q3 that we were seeing progress on the Foodservice side and that continued and it was manifest you guys can follow the way the numbers tumbled. On the Retail side as far as the external environment it honestly remains very, very contentious. There are contentious discussions in some cases where we're seeing less price realization in other cases we're getting it through pulling back on trade and things like that.
So, I would say that the environment remains more or less consistent with what I outlined in Q3. The way we're getting there in some cases is less and other cases it ends up being by pulling back and trade. Like you I keep track of sort of commentary from peers in this space and I think what we're experiencing is quite consistent with what they're experiencing.
Okay, thanks. That's helpful. Last one from me, just quick following on from the prior question, the last question you asked about Foodservice and the magnitude of growth there. So if we wouldn't ascribe too much of that growth or not a significant portion of your Foodservice growth to LTOs in Q4 and we think about kind of a setup that you have going into ’19, I mean should we - can we take from this that sort of something at least in the mid-to-high single digit top line growth range for food service is realistic for ’19, is that a fair characterization of sort of how you're set up?
I wouldn't be that that bold at this point. I think I would back off that some honestly. Things are starting to place nicely this time around. If I step back and sort of look at what we or give you maybe the way we view the business internally, first of all the overall economy seems to be humming along at a much stronger pace.
I think consumers are seeing the benefit of more money in their pocket and higher consumer confidence. And it seems to be benefiting the traffic at our restaurants. So we looked at Technomic data recently and we could see if you look at the 200 largest national accounts, all of them seemed to be seeing a measure of benefit in traffic and in terms of a little bit higher ring from what's happening. We're also seeing this as it pertains to our mix of customers.
All that being said, it's hard to say that we continue to grow in this segment at the rate at which we do, because in some respects we were lapping some easier comps. I would expect to see something and I'd probably say in the low single digit range on a normalized basis across the entire segment today.
It is just where I am, now that's coming off really if you looked at the segment where it's probably running, let's call it down 50 basis points in some cases down 100 basis points. So I think you've seen an inflection point, but I would be reticent to say that I expect to see it in the entire industry and in our business run in the mid-to-high single digits. I just I don't see the fundamentals there to support that Brian.
Okay, thanks. That's helpful, I appreciate it.
Sure, thanks.
Your next question comes from Brett Hundley with Vertical Group. Your line is open.
Hey good morning guys.
Hey Brett, good morning Brett.
Good morning, Brett.
Congratulations on a good quarter here in a tough environment. I wanted to ask you, I wanted to go back to the margin outlook and try and get a better handle on gross margins. So if I heard everything correctly you guys finally got to PNOC in the positive territory during Q4 correct?
Yes.
Okay and the reason I want to confirm that is because your gross margin performance was pretty solid. It was close to last year when you consider that for much of the year you've been trending 150 to 200 basis points below the prior year. And then you guys finally got close to even during the quarter. I guess what I'm trying to understand is when I think about the impacts that have weighed on you during fiscal ’18 and I try and think about how to put my model together for fiscal ’19 and fiscal '20 the way I've always kind of lined things up is, you know look, as you guys went through fiscal ’18 you had this commodity drag that was upwards of 100 basis points by my math.
You had a freight drag that I think was close to 100 basis points if I'm not mistaken, and then you had a garlic bread issue that weighed on you that you've now gotten around. All along you've been lagging with pricing and trying to recover a good portion of that or pricing related efforts and you've also had your Lean Six Sigma efforts and if I'm not mistaken, I think a lot of the cost saving efficiency work that you've been trying to drive is potentially upwards of 200 basis point impact to margins if not more over time.
And so you can correct me if I'm wrong on any of these, but the point I'm trying to make is, if you guys are able to get PNOC positive and let's say there comes a point during fiscal ’19 where you recover freight, you recover commodities and you're even again, those Lean Six Sigma efforts all else equal should really flow in and give you guys some really nice margin improvement potentially as you exit fiscal ’19 and fiscal '20. But I just want to make sure that I'm on the right track there because if your PNOC was positive in Q4, ‘18 I would have maybe expected better gross margin performance. So maybe you can just help me tie all this together, I hope that makes sense.
So, I’ll take you through a couple of things, maybe starting first with kind of an update on our Lean Six Sigma program. It continues to be up and running. With every passing quarter we graduate another class of Greenbelt and the program gets more complete seated into the organization. I think I mentioned in a prior call we were achieving somewhere in the mid 7 figures of savings every single quarter and that seems to be where we've sort of got the organization up to a gallop and we continue to run at that pace. So you're exactly right on that piece Brett.
Maybe it might be helpful to sort of help your true up sort of PNOC versus margin. When we think about pricing really there's two things. The first thing you want to do is you want to cover the cost in the absolute sense and that's sort of what PNOC gives you. And then you want to make sure that you're getting enough pricing to not only cover your input costs, but to continue to protect your margins. Right? So pricing to go in excess of PNOC and get margin protection. What we've done this time through is we're getting the PNOC and PNOC by the way includes both pricing and the cost savings, both components of that, has exceeded the amounts that we're seeing in the input cost.
The reason why you're not seeing necessarily flow all the way into holding margins or expanding margins is there's still an increment that that we haven't completely covered, that we're working against which is that difference between covering the inflation to cover the input cost and also expanding it beyond that to hold onto our margins. That the piece that's happening just as a little context for why there was a little further unwinding in this period.
Now fast forward, how do we think about fiscal year ‘19. Overall sort of in reference to Mike’s question earlier in our commentary here, we expect to see - based on what we're seeing today in that commodity environment a sequential improvement for the year overall. We do expect to see that the first half is going to be way down because of the continued elevation of freight costs. It's for us in the industry it's a big number and we have two more full quarters of that to hit and one more quarter of eggs.
So I think that's why we're saying we're going to see a bit of a drag. I think you would expect to see that the story continues to improve, but as far as it is more significant building, it's probably going to be back half just honestly because of the factors that I described. Egg inflation in Q1, all of inflation, but egg inflation predominately and then trans inflation for the first half.
That's really helpful, so as we get through H1 of ’19 would it be your hope that by the end of that time period so heading into H2 that that final increment of pricing is through for you guys, I mean all else equal?
I'd like to think so based on what we're seeing right now. And I think it also - as we think about '20 and the period thereafter, we're sort of assuming that we're going to see sort of a low grade of inflation on a going basis, hoping not to the degree to which we saw in fiscal year ’18, but as we think about sort of inflation versus deflation, we're expecting a continued inflationary environment, probably somewhere in the half of the range that we were seeing in the most recent year.
And I think it's because of the strength of the economy, it's because of things like liner board and corrugate where the owners are almost oligopoly, a resin supplier that tend to operate the same way, those are areas where it continues to be tough. So we're expecting that the combination of our Lean Six Sigma program and good careful pricing is going to allow us to continue to improve our margins and offset inflation.
Is labor included in that, has labor costs popped up for you in any meaningful way?
It has, if you think about our business roughly two-thirds of our absolute costs come from raw material and packaging and about a third of the costs are in conversion of which labor would be a component. We are seeing labor, the most significant place where labor is biting us is in freight because it's really - we don't have a truck shortage, we have a trucker shortage and that's where you're seeing that that inflation.
Parenthetically some of the things that we're doing in the space of Lean Six Sigma things like automating the end of lines with palletizers and stuff like that are helping to take the edge off of some of the labor pinch that we're seen in our factories. And that's part of our long term plan honestly is to figure out where can we invest in automation to take out unskilled labor, so we're relying more predominantly on true skilled labor that helps us today and as we think into the future about things like healthcare costs, worker's comp costs and everything else it will help us as well.
The last thing I just want to ask you is on your reduced rates spend and couponing, I think that was something that was certainly well-planned, heading into the quarter I think you guys talked about that on your on previous call actually and you mentioned rate spend optimization tools.
You've talked about that at length, can you just delve more into the nature of these decisions, how quickly they're being made at corporate? And related, have you been able to measure the effectiveness of these decisions? I think that these actions are somewhat newer for you guys, but I'm curious if you've been able to measure effectiveness and whether these tools are working net-net for you guys?
Yes, so we – I think probably about a year ago or so we talked about our priority to invest in this space and we've invested in sort of a range of elasticity tools and others and essentially what we've done are two things, one we have centralized some of the decision making around for example, should you run a promotion at two for five versus two for six into a group of folks that are running the modeling on the elasticity, so we know when we're getting a good economic payback for a price and when we're not. And then what we're doing is there are folks further out in the field that are working to focus on execution versus what those pricing decisions should be.
So, both the tools and the process are in place and ideally what we're doing is on an interim basis looking in each of our categories whether it's bakery items or dressings and dips and making those decisions in the context of competition and the inflation and everything else.
What I would tell you is, as with any other pricing decision it requires time with the customer where we sit down and we sort of explain to the customer why we would like to move away from a burger to let's say a two for five or a two for six, sometimes they balk [ph], sometimes they don’t, if we feel very strongly about it we will really toe the line.
If they can create the case with some sort of value-added provision for why that might make sense, we might listen to them and we always work with them. But we may decide to go their route, but I think culturally what's evolved here is we're really using the tools, we're for centralizing the strategic decision-making within the retail business around those tools and the folks in the field are just focusing on a bit more on just good execution.
Thanks for the comments.
Thanks Brett.
Thanks Brett.
[Operator Instructions] Your next question comes from Frank Camma with Sidoti. Your line is open.
Thanks, good morning.
Hi good morning, Frank.
Hi good morning, Frank.
Hey, you kind of gave us some flavor on some increase here on the capital allocation with the CapEx, just wondering if you could comment on the acquisition environment, any changes there given what's going on just and can you just give us updates?
Sure, so great question, Frank. We remain really active in that space. I will tell you that we have a range of things that we've started to continue to work through, but that's sort of an evergreen process. As far as sort of specifically the pricing environment, valuations remain lofty even as interest rates go up. We haven't really seen a material change in valuations and expectations, but rest assured we're very aggressively on the marketplace today.
Okay and then so given the fact that you still have an excellent balance sheet, lot of excess cash, does it ever make any sense to build out even partially your own freight network or is it just not practical given your different lines?
No, it's a great question. So today if you look at our business you know sort of by history we're heavily dependent within the broker space. If you think about it essentially it falls into one of three categories where you can own your own assets, you can work with dedicated providers with longer-term agreements or you can go out and buy on spot market. But by tradition here Frank, we have been heavily reliant on the spot market where during times where there was a glut of trucks and drivers we were a beneficiary.
For you folks, you think about it this way, this is the way I thought about it. In an interest rate world we were floating versus fixed. Now fast-forward when things changed all of the sudden spot market prices went up more aggressively. Now more nearly into your question, we are looking at doing both, addressing it two ways; one we are in the marketplace looking to secure drivers and assets. We have a small group of drivers today at our own assets and we use those today in our most expensive lanes.
What we also did just this past quarter is we put out an RFP where we talked to some of the biggest national freight providers and we're looking to expand our utilization of dedicated freight which essentially allows us to have many of the same benefits of owning the assets, but without having to own it. There's a big difference when you own the trucks you can ship the product outbound to the customer and then you can benefit from any sort of backhaul that you can generate. We can generate that same sort of benefit with backhaul by going to dedicated. So we are in the process actively of implementing the expansion of this dedicated work and based on the results of the pilot we would expect to expand at even further.
Great, thanks guys. That's helpful.
Yes, and just last point if I may Frank. Just ultimately get into position where freight cost as with other commodities are more predictable for us. We don’t like the volatility and we know that you folks don’t either.
Right, thanks.
Thanks Frank.
Thank you, Frank.
Your next question comes from Brian Holland with Consumer Edge Research. Your line is open.
Thanks just a quick followup. Going back to the balance sheet I think I believe I have this right that in 2015 and in 2015 you paid a special dividend out. It sounds like there's a lot of stuff still in the pipeline from an M&A standpoint. I think within the past year or so there's been a more stated preference for M&A as a use of capital as opposed to maybe dividend or stuff like that. But just sort of curious if you could reset for us kind of what your priorities are for capital allocation and maybe wear something like a special dividend or what have you where that might fall in line relative to M&A et cetera?
Brian, this is Doug. You know, I don’t think much as changed since we've last communicated our thoughts on capital allocation. I think as Dave has mentioned the number one opportunity is certainly to invest back into our business as we've discussed here today and then certainly as we've mentioned in our earnings release and the like, certainly to continue to look to extending our dividend increases.
Beyond that, M&A is clearly in the forefront of our minds and it would be our desire to look for an M&A opportunity before issuing any sort of special dividend, but you know we continue to evaluate that as we go through time. So again, I don’t think much has changed since our last commentary on capital allocation.
Thanks, I appreciate that.
Sure thanks.
If there are no further questions, I will now turn the call back over to Mr. Ciesinski for his concluding remarks.
Thanks Denise and thank you everyone for joining our call. We look forward to giving you guys and update on our progress in the fall and in the meantime we look forward to seeing you guys out in the marketplace.
This concludes today's conference call. You may now disconnect.