Ralcorp Holdings: Announces Results for Q1/2012

St. Louis / MO. (rh) Ralcorp Holdings Inc. reported results for the quarter ended December 31, 2011. Ralcorp´s results include the operations of the North American private-brand refrigerated dough business of Sara Lee Corporation (Refrigerated Dough) since it was acquired on October 03, 2011. Additionally, results include the operations of the Post cereals business (the Branded Cereal Products segment), which was distributed to shareholders effective February 03, 2012 and now is a separate publicly traded company named Post Holdings Inc.. Unless otherwise indicated, all comparisons of results in the following discussions are for the first quarter of Ralcorp´s fiscal 2012 relative to the first quarter of fiscal 2011 ended December 31, 2010.

Net Sales

Net sales increased 18 percent, largely due to the acquisition of Refrigerated Dough. Base-business net sales increased nine percent as a result of an increase in overall net pricing due to adjustments in response to higher raw material (ingredients and packaging) and freight costs, partially offset by an overall one percent volume decline. Excluding sales of the Branded Cereal Products segment, base-business volume was flat compared to a year ago.

Margins

Gross profit margin was negatively impacted in fiscal 2012 by 5,8 million USD of net adjustments for economic hedge contracts as well as a 1,6 million USD inventory adjustment related to acquisition accounting for Refrigerated Dough. In fiscal 2011, gross profit margin was positively impacted by 4,8 million USD of net adjustments for economic hedge contracts. Excluding the effect of these items, adjusted gross profit margin decreased from 26,7 percent last year to 24,9 percent this year. Base-business raw material and freight costs (net of hedging activities) were approximately 112 million USD higher, with the most significant impact in snack nuts (included in the Snacks, Sauces + Spreads segment) and durum wheat (included in the Pasta segment). Most of these rising commodity costs were offset through a combination of pricing adjustments and savings from cost reduction efforts, but the resulting impact of the higher costs offset by higher sales reduced gross margins (gross profit as a percentage of net sales) by approximately 2,3 percentage points. This negative effect was partially offset by the positive impact of the addition of the higher-margin products of Refrigerated Dough and favourable manufacturing costs overall.

Selling, general and administrative (SG+A) expenses as a percentage of net sales decreased a tenth of one percentage point compared to the prior year. The SG+A percentage was negatively impacted by merger and integration costs and Post separation costs in fiscal 2012. Excluding the effect of these items, adjusted SG+A expense as a percentage of net sales declined from 12,6 percent to 12,2 percent. The improved rate was driven primarily by the effect of sales growth (as described above) outpacing SG+A growth for most of Ralcorp´s segments, especially for Snacks, Sauces + Spreads, for Pasta, and for Other Cereal Products. Rates were also positively affected by a decrease in costs related to information systems projects. These decreases were partially offset by increased advertising expense in the Branded Cereal Products segment as well as an increase in mark-to-market adjustments for certain stock-based deferred compensation.

Total amortization expense for the first quarter of fiscal 2012 was 24,0 million USD (0,28 USD per diluted share) compared to 19,5 million USD (0,22 USD per share) a year ago. The increase is primarily due to the acquisition of Refrigerated Dough. In addition to the items discussed above, the first quarter operating profit margin was affected by other merger and integration costs (primarily in the current year) and a provision for legal settlement (in the prior year only).

Adjustments for Economic Hedges

Certain derivative contracts do not qualify for cash flow hedge accounting but are used as economic hedges of the Company´s exposure to changes in commodity costs. Realized and unrealized gains and losses on such contracts are recognized at a corporate level but not allocated to affect segment operating profit until the hedged exposure affects earnings. In the first quarter of fiscal 2012, net mark-to-market losses on such derivatives totalled 5,8 million USD, and net gains totalling 3,6 million USD were reclassified to segment operating profit, resulting in a net adjustment for economic hedges of 9,4 million USD loss. In the prior year, net mark-to-market gains on such derivatives totalled 4,8 million USD, and nothing was reclassified to segment operating profit, resulting in a net adjustment for economic hedges of 4,8 million USD gain. This net adjustment was recognized in cost of goods sold on the statement of earnings but excluded from segment operating profit and the Company´s non-GAAP measures of Adjusted Ebitda and Adjusted Diluted Earnings per Share.

Post Separation Costs

During the quarter ended December 31, 2011, Ralcorp incurred 2,7 million USD of costs (primarily professional service fees) related to the separation of the Post cereals business from the other Ralcorp businesses. These Post separation costs are included in «Selling, general and administrative expenses».

Merger and Integration Costs

During the three months ended December 31, 2011 and 2010, Ralcorp recorded approximately 5,6 million USD and 0,2 million USD, respectively, of expenses related to acquisition activity. In 2012, those costs related primarily to the acquisition of Refrigerated Dough including a one-time finished goods inventory revaluation adjustment. Of the 5,6 million USD net merger and integration costs recorded in the three months ended December 31, 2011, 1,6 million USD is included in «Cost of goods sold», 1,4 million USD is included in «Selling, general and administrative expenses», and 2,6 million USD is included in «Other operating expenses, net».

During the three months ended December 31, 2010, the Company increased its accrual by 2,5 million USD related to certain contractual claims by a customer. Those claims arose primarily as a result of the customer´s recall of certain peanut-butter-based products in January 2009 and were subsequently settled for a total of 10,0 million USD. The provision for legal settlement is included in «Other operating expenses, net».

Interest Expense and Income Taxes

Interest expense decreased 1,3 million USD due to a decline in the weighted average interest rate. The weighted average interest rate on all of the Company´s outstanding borrowings was 5,1 percent and 5,6 percent in the quarters ended December 31, 2011 and 2010, respectively. The effective income tax rate was approximately 35,5 percent in the first quarter of 2012, down slightly from 36,0 percent in last year´s first quarter.

Segment Results

Branded Cereal Products: Net sales declined three percent as the impact of lower volume was partially offset by increased net selling prices in response to higher raw material costs. Volumes were down across most of the Post brand portfolio with the exception of Great Grains, which grew 13 percent driven by increased advertising support. Segment operating profit decreased 30 percent as a result of increased marketing investments, higher raw material costs (driven by wheat, nuts, and corn), unfavourable manufacturing expenses (due to the negative impact of lower production volumes on plant utilization and fixed cost absorption), and lower volumes. These unfavourable variances were partially offset by increased net pricing and favourable warehouse and broker expenses.

Other Cereal Products: Net sales increased eleven percent as higher net selling prices (raised in response to commodity cost increases) and a favourable sales mix (with a shift to nutritional bars, which have a higher price per pound) were partially offset by slightly lower overall volume. Volume declines in hot cereal, foodservice, co-manufacturing, and other minor categories were almost completely offset by volume gains in nutritional bars and ready-to-eat cereals driven by new product sales, expanded distribution of existing products, and strong promotional programs. Segment operating profit increased 28 percent as improved net selling prices were only partially offset by higher raw material costs (driven by oats, corn, wheat, fruits, and nuts), production costs (primarily nutritional bars), freight costs, distribution costs, and customer promotion costs.

Snacks, Sauces + Spreads: Net sales grew 13 percent as a result of increased net selling prices and higher overall volume, partially offset by increased trade promotion spending. Net selling prices were raised in reaction to significantly higher commodity costs across many of the segment´s product categories, but most notably in snack nuts. Segment operating profit increased ten percent driven by improved net selling prices, a favourable sales mix (primarily due to higher cracker and cookie volume and lower snack nut volumes), and favourable manufacturing costs. Those beneficial effects were partially offset by the effects of significantly higher raw material costs (primarily cashews, peanuts, and tree nuts, but also including oils, wheat, and packaging), freight costs, information systems costs, and brokerage costs.

Frozen Bakery Products: Net sales were up 59 percent primarily attributable to incremental sales from the acquisition of Refrigerated Dough. Excluding results from this acquisition, base business net sales were up seven percent driven by price increases in response to commodity cost increases, partially offset by slightly lower volumes. Volume gains in foodservice were offset by the effects of volume declines in retail griddle products and the in-store bakery channel (primarily frozen dough and bread). Foodservice sales benefited from a new product for a major restaurant chain. Segment operating profit was up 47 percent primarily due to the acquisition of Refrigerated Dough. Excluding this acquisition, segment operating profit decreased 19 percent driven by higher raw materials (primarily flour, dairy, and eggs), freight, and increased information systems costs as well as unfavourable foreign exchange rates, partially offset by improved net selling prices.

Pasta: Net sales were up 17 percent due to higher net selling prices in response to rising raw material costs, partially offset by lower volumes. Retail sales volume was down one percent with small declines in private-brand and branded products. Institutional volumes declined three percent, due to lower ingredient and foodservice sales, partially offset by higher co-manufacturing volume. Segment operating profit decreased five percent due to lower sales volumes and net selling price increases not completely offsetting significantly higher raw material costs (primarily durum and semolina wheat).

Outlook

Effective with Ralcorp´s second quarter financial reporting, the Company expects to report Post as a «discontinued operation», and thus Post will be excluded from results from continuing operations. All comments included below exclude the fiscal 2012 operations of Post.

Ralcorp incurred significant amounts of raw material and freight cost increases during the first three months of fiscal 2012. For fiscal 2012, the Company currently expects the net year-over-year increase in unit costs for raw materials will result in a ten to twelve percent increase in cost of goods sold, with the most significant impact in its second fiscal quarter. The primary commodities driving this estimated increase are durum wheat, cashews, tree nuts (particularly almonds and pecans), and peanuts. Excluding durum wheat and snack nuts, this increase is expected to be five to six percent after the effects of hedging and forward purchase contracts. To offset the impact of these significant cost increases, the Company expects to take additional actions, including aggressively reducing costs through ongoing continuous improvement and other initiatives and increasing prices when justified. The timing of these pricing actions and acceptance by customers is expected to lag cost increases, particularly in the first half of fiscal 2012 for the Pasta and Snacks, Sauces + Spreads reporting segments. The Company expects that operating results in the second half of fiscal 2012 will improve for both segments as pricing and commodity increases become better aligned.