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Leading Brands, Inc. F1Q08 (Qtr End 05/31/08) Earnings Call Transcript

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Leading Brands, Inc. (LBIX)

F1Q8 (Qtr End 05/31/08) Earnings Call

July 8, 2008 11:00 am ET

Executives

Ralph D. McRae - Chairman, President, and Chief Executive Officer

Analysts

Lorne Trabova – Private Investor

Ted Alunka – Trident

Michael Salzhauer - Benjamin Partners

George Mazenski – Private Investor

Gregg Colburn - Interlachen Capital

Geoffrey Aronson - Consensus Partners.

Rob Williams – Private Investor

Presentation

Operator

Good morning, ladies and gentlemen. Welcome to the Leading Brands First Quarter Earnings Conference Call. (Operator Instructions) As a reminder, today’s conference is being recorded. Today is Tuesday, July 8, 2008. I would now like to turn the meeting over to Mr. Ralph McRae. Please go ahead, sir.

Ralph D. McRae

Thank you and good morning. I hope it’s as bright and sunny where you are as it is here in Vancouver. I will start off by reading our Safe Harbor language.

The company relies upon the Safe Harbor Laws of 1933, 1934, and 1995 for all public statements. Statements which are not historical facts are forward-looking statements. The company, through its management, may make forward-looking public statements concerning its expected future operations, performance, and other developments. Such forward-looking statements are necessarily estimates reflecting the company’s best judgment based upon current information and involve a number of risks and uncertainties and there can be no assurance that other factors will not affect the accuracy of such forward-looking statements. It is impossible to identify all such factors. Factors which could cause actual results to differ materially from those estimated by the company include, but are not limited to, general economic conditions, weather conditions, changing beverage consumption trends, pricing, availability of raw materials, economic uncertainties including currency exchange rates, government regulation, managing and maintaining growth, the effect of adverse publicity, litigation, competition, and other factors which may be identified from time to time in the company’s public announcements. All financial amounts referred to are in US dollars unless otherwise specified.

Gross revenue for the quarter was $9.315 million versus $10.558 million in Q1 of last year. The reduction in revenues was principally attributable to the loss of Hansen energy drink distribution rights and reduction of co-pack revenues associated with the consolidated of the company’s two bottling plants in its Edmonton facility, both of which events occurred in the middle of Q1 last year. This will be the last quarter of comparative revenue reductions due to those factors. I am sure you are happy to hear me say that.

Sales of the Company's proprietary branded beverages rose 32.9% over last quarter, despite incredibly a cold and wet spring across most of Canada and the Northern U.S., which conditions directly impact overall beverage consumption.

Gross profit margin, before discounts and slotting fees, for the quarter increased to a record 42.0%, from 35.5% last quarter, and up from 33.7% the previous fiscal year. One of the most significant drivers in this percentage margin growth was improving efficiencies in our bottling operations. Achieving these margin levels and continuing this positive trend are key developments for our company and I will expand upon this later.

Net loss for the quarter, before other income, which in Q1 last year included $1.227 million from the Hansen's buyout, improved to $571,000, or $0.03 per share, from $1.412 million, or $0.09 per share, in Q1 last year. Net loss after other income this quarter was $556,000, or $0.03 per share, versus $185,000, or $0.01 per share, in Q1 last year.

Discounts, rebates and slotting fees rose slightly to $1.159 million from $1.020 million in the same period last year. Non-cash stock-based compensation expense for the period was $69,000, a drop from $82,000 in Q1 of the prior year.

SG&A expenses were $3.039 million, down more than 9.0% from $3.344 million in the same period of fiscal 2007. SG&A costs decreased throughout the quarter and continue to do so in the first month of Q2.

Cash available credit at quarter end was approximately $3.3 million, a decrease from about $4.0 million at the end of February, but much of that change was due to increased working capital requirements, building inventory heading into spring and summer, and also prepayment of listing fees that will be amortized over the ensuing year.

EBITDA improved significantly over last quarter to a negative $280,000.

At the beginning of this fiscal year we internally established a goal to reduce our breakeven from approximately $4.0 million in gross sales per month to around $3.0 million. Our efforts were focused on achieving that through a combination of increased percentage gross margin, savings in operating costs and reductions in SG&A expenses. By the latter part of Q1 we were close to our goal. In other words, not only the savings, reductions, improved efficiencies that were achieved by the last month of the quarter were in place during the first month of the quarter. That positive trend continues into Q2.

Not only will these improvements drive greater profitability at higher sales levels, they will also make our business much more manageable in the slower winter season. We anticipate our gross margin, before discounts and slotting fees, will hover around the 40% level for the next quarter or two before additional margin enhancement initiatives work their way fully through our system.

Now, I want to be as clear as possible in my explanation on our goals and business plan in the present economic environment. Without sounding too academic or melodramatic, I believe that the developed world is headed into an extended period of stagflation, meaning a stagnant economy dogged by persistent cost of living increases that eat away real incomes and net worth. If there is a more potentially harmful economic state, particularly for the middle class, I am unaware of it.

Despite the motivated prognostications of the financial news talking heads, the U.S. is already well in the grip of stagflation. It is now creeping into Europe. Canada, which has for the most part been relatively immune, will not continue so indefinitely.

This phenomenon is driven principally by oil prices, which to date have been most manifest at the pump. With greater frequency and intensity prices are being driven up in almost all sectors, including grocery and convenience store shelves. The impact on virtually company is significant and those selling consumer products are no exception.

The cost of ingredients, packaging materials, and freight are all subject to upward cost pressures. Manufacturers, brand owners, and distributors alike need to improve how they get their products to market. Better business models have to be developed so that the increasing prices and a suffering economy, although an easy answer for some, is far from the optimum solution.

One of the first victims will be the direct-to-store DSD distribution system that so many other beverage companies rely almost solely upon. It is simply not cost effective any more. If you have been watching closely over the past month you have seen a dramatic consolidation of food and beverage channels in Britain, where distances are measured in hundreds, not thousands of miles as they are here. Something similar needs to occur quickly in North American or many companies that rely on these DSD models will start to falter.

Luckily for us, we have built our business around other ways to market and I want you to keep that in mind as you see news come out over the next several months, generally in the food and beverage business.

Disappointingly, I do not believe that we, as individuals in the developed world, can do much to influence the current macro economic situation. It will not correct until one or two things occur: either there is a material drop in GDP growth in the BRIC countries, or meaningful new energy source or technology is found. Neither of these, in my opinion, is likely to occur any time soon.

Every time we, in turn, turn over one of our SUVs for a Prius, someone in India, Russia, or China buys a first car, etc., etc. Our only option is to adapt. Fortunately, we anticipated these developments many months ago and seemingly everyone pondered whether we might ever see $100 a barrel oil. We set out in earnest last fall to better adapt our business model to the present and pending realities.

Could we have just raised prices like many of our competitors? Sure we could. But we know that we are better served over the longer term by striving for even greater efficiencies and maintaining price integrity with our customers and consumers. We have consequently made several meaningful changes in how we go to market; we will continue to do so. By far, the best evidence of what we have done can be found in our increasing gross margin, a trend which has been consistent for several quarters now and which stands in stark and positive contrast to our peer group.

There is a positive message to take from this gloomy macro economic prophesy and that is this. We have positioned Leading Brands to buck the economic headwinds that I have just described and deliver improving margins in spite of increasing commodity prices. We believe that if we continue to evidence this from quarter to quarter we can stand apart from the crowd, and I have said to many of you over the years, what you are buying in Leading Brands is not only our brands, but also our integrated distribution system: our different way of going to market.

Having said that, a critical component of our strategy is, of course, our brand portfolio itself. One of the last things that intelligent consumers will sacrifice, even in hard economic times, is their health. Luxury items may be pushed aside. Gone will be the little 8-oz. bottles of red juice selling for $4.49 each, but both the lifestyle and concept of healthier living will not be abandoned. That is what I love about our brand line-up, which is the definition of affordable health.

So with that, Michael, I am pleased to entertain any reasonable questions that they may have.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Lorne Trabova.

Lorne Trabova – Private Investor

That’s great numbers and I was very happy to see that the breakeven number is coming down into the 30% range. It’s got to be tough doing business right now. My question is, how are you working with your suppliers? You have got to be seeing a lot of increases in packaging, especially with the price of oil. Are they really bending over backwards for you? Are you coming out with lighter-weight containers?

Ralph D. McRae

It’s a combination of a lot of things and the packaging materials are certainly one of them. But in any package are at least three major input components. One is the packaging materials, as you mentioned. The other is, and for us is a higher percentage component, which is the cost of the juice, and then the last one is the freight and the life associated with moving that around.

We don’t want to go after the things that mean a lot to the customer so we want to maintain our packaging integrity, we want to maintain the quality of our juice, and the first things that we’ve gone after are the ones where people are seeing the greatest percentage increases and that is in freight and transportation.

So, like I’ve said, there was actually a remarkable announcement that came out of the U.K. last month where Coke, Pepsi, Proctor & Gamble, Tesco, I mean to name a few of 40 or 50 food suppliers, all got together and jointly consolidated their distribution operations. Everybody else said, “Oh, gosh, that’s because it costs $7.00 a gallon for gasoline.” It may cost a lot in Britain but the fact of the matter is they travel significantly shorter distances to deliver products. What we have done is we have gone after that part of the equation first.

As I’ve said in the introduction to the call, we still have a lot of other things to look at and do and we are actively looking at that, including the way we interact with our customers, including the way that we manage our business, and who does what internally, and controls and limitations that we put on the things that people can do within our company, to try to restrict that.

And like I said, right at the very outset, one of the biggest contributors to this margin improvement over the last while has been the people in our plant operations who have just done a stellar job in getting our products through. And I know some people think it’s taking them to the [inaudible] and things like that, but you’ve got to give credit where credit is due.

Lorne Trabova – Private Investor

Absolutely, and it’s a tremendous amount of work moving all that equipment and maintaining operations at the same time so I’m glad you recognize their efforts. It’s been a tough year to be a Leading Brands shareholder, as I’m sure you know, but I see light at the end of the tunnel now and hopefully within a year or two we are going to really see some positive results in the bottom line.

Ralph D. McRae

Yes, and I appreciate your comments about the results were good. The results were good for us when those red numbers disappear and that’s what we work towards.

I can’t overstate this enough, when that Hansen’s deal got dropped on us on no notice, about 16 months ago, that was a significant portion of our contribution and the work that had to be done to react to that and deal with that, and luckily now every aspect of that is behind us, but it was no mean feat. And I know that people struggled through that, I know people dealt with that, but what you have coming out of that is a company that is much more self-reliant and has much more upside with the value of its own brands and I think that that was, in retrospect, although an unpleasant but a worthy effort.

Lorne Trabova – Private Investor

I appreciate your efforts and hope that the team continues to work in the right directions.

Operator

Your next question comes from Ted Alunka of Trident.

Ted Alunka – Trident

Congratulations on some improved numbers. I’m glad to see the margins up. I also do share in some of your macro economic views, with the stagflation and so forth.

I guess the question is, and I think I might be of some help to you, because I’ve got 25 years on the Street with microcap stocks, I think it would be very beneficial to have the CFO on the conference calls and I’m a little confused, quite frankly, as to why he’s never there.

Ralph D. McRae

Well, because he is a she, in the first place.

Ted Alunka – Trident

I apologize. So what’s the real reason?

Ralph D. McRae

I think that at the end of the day, what I find is that people want to hear from me. And having our CFO here just to state the numbers, if you want a number that you want to have given to you and I can’t provide it to you, then that’s a worthy request.

But, quite frankly, I think that it looses some quality. When I listen to people’s conference calls and everybody is gathered around the speaker phone and they’re cutting each other off and it’s hard to hear, I don’t find those as constructive. Now, you obviously have a different view of that than I do, Ted, but I’m just telling you I think this is a better opportunity to ask somebody rather than to have somebody that has to ask the coach what they say.

Ted Alunka – Trident

I understand. I just wanted to say in light of the fact, and again, I’m not picking on this and I am happy with the improvement, I want to be very clear with that, but I would like to say in light of the fact that we did have a CFO that was there for a very short period of time, for whatever the reason, perception, unfortunately, very often rules in the stock market. So we are here to benefit the shareholders and discuss and bring forth and so forth.

In light of the fact that we have had a CFO who has been here for an extremely short period of time and left, for whatever the reason, I think it would help to hear from the new one and I think it would be beneficial to the perception. Not implying anything is wrong. I just think it would help the perception. Because it’s clear your company is going in the right direction. I think it would only help.

Ralph D. McRae

Okay, and let me just clarify one of the things you said because I just want to make sure that everybody understands this. The new one is the old one. What happened was very simply, and maybe this is part of the confusion, Donna Higgins was our last CFO and has been with the company now going on towards 10 years. Donna decided that she wanted to get married and part of that decision, with her and her husband, was that she didn’t want to spend as much time, particularly around the quarter ends and all the work that needs to go into year end to finish off that, and particularly, I’ll add on this, with the upcoming stock compliance stuff that we just went through.

So she decided she wanted to take more time with her family and then we brought in this new fellow. There’s nothing wrong with the new fellow other than we have some very good and very loyal people here. He didn’t get along with them, for whatever reason. At the end of the day I was left with a choice: I was going to lose a bunch of long-serving very valuable people in this company, or I had to deal with the person who I believed was causing that disruption. I made a choice.

And frankly, Donna had, just at time, realized that semi-retirement wasn’t all it was cracked up to be and kindly agreed to come back into the position. I think it’s important to understand that sequence of events.

Ted Alunka – Trident

Okay. I’ll say, again, in closing, thank you and congratulations on the improvement. I’m on board, I’m a big believer.

Operator

Your next question comes from Michael Salzhauer with Benjamin Partners.

Michael Salzhauer - Benjamin Partners

Thanks for staying there and working hard for all of us. You raised the issue of we are buying a beverage brand company and a distribution company. I realize that you were bit very badly by Hansen’s, but has anybody of any interest approached you about taking advantage of the distribution system and is that something you would consider again?

Ralph D. McRae

It would be an exaggeration to say weekly, but it’s more than monthly, that people call up and want to talk to us about using us to distribute their stuff. We went through this the first time with SoBe. We built a brand up, it got sold, we got peeled, at that time it was significantly greater than the Hansen’s one, and we did it again with Hansen’s. And frankly, I think we do a lot of work and a lot of effort to help other people grow their products and if, in their eyes, we don’t do a very good job, they want to change us, if we do a great job, then they sell. There’s not real great ending for those types of scenarios.

And I really also don’t like the mentality of dealing with beverage companies that are being built to sell. They do silly economic things. They try to sell products at too low a price that are unsustainable and they try to force you to do those same types of things.

So it’s a difficult one. It would have to be a pretty amazing product. We would demand a contract that would embrace the brand in perpetuity and people who want to sell their brands don’t want to do that sort of thing. So it gets to be a difficult discussion. But people do certainly phone here and talk to us about it regularly and there’s just been nothing that has struck my fancy and I come with that prejudice.

Ted Alunka – Trident

Nobody would offer you a piece of equity?

Ralph D. McRae

We get offered that all the time. Somebody who has never been in the beverage industry wants us to invest a certain amount of money and time and effort and distribute their product for them and they will give us equity back for that.

I haven’t seen a model, so far, that is appealing to me in that regard. If it were something that they would allow us to manage and that they contribute a portion of and there was some sharing of the ultimate equity in significant stocks, yes, we would look at them all like that. But it has to be a real special product.

Ted Alunka – Trident

And then otherwise, can you comment on how sales are doing in the stores that you’ve been in for some time in the United States?

Ralph D. McRae

Yes. They’re up, materially. I don’t want to get into too specific numbers, because again it’s competitive issues, but they’re up significantly. There’s not a significant chain where I’ve seen the numbers for where we’re down in same-store-related sales. A large part of that has to do with what I talked about six or nine months ago, which was getting more juice on the shelf to create greater presence.

And again, as people were being quick to point out, we have pressed some change with that. They haven’t liked what we have pressed back at them. We’ve been out of and been back into change. And when we’ve come back in, the sales jump is remarkable. When we come back in on the right casings and the right circumstances.

Operator

Your next question comes from George Mazenski, a private investor.

George Mazenski – Private Investor

First of all, congratulations to you and your team. Obviously you guys have done an outstanding job of trying to navigate through what is a very difficult environment. I have a couple of questions and they’re both closely related.

With regards to product placement, I live in the Northeast and Mid-Atlantic region and I’m constantly looking for the new products that are coming out. STOKED hasn’t reached us yet. True Blue has come in and out of a couple of places.

What my question to you is, what are you trying to do in the Northeast and the Mid-Atlantic region to try to expand product exposure and is there anything we can do as investors to help you out in terms of following up with these grocery store chains and trying to get more Leading Brands’ products into these stores?

Ralph D. McRae

Just on a retail basis, it never hurts, and we tell our people to do this and I do it when I go into stores, is when you go up through the store and you see a manager walking around the aisles, and say, “I was looking for this True Blue product, looking for STOKE, looking for Die Hard. Can you find out why you don’t have it? It’s a great brand. I love it.” So that’s great.

Phoning and harassing buyers, as some people try to do, those are very, very busy people that are pestered by a lot of brand companies. You have to set appointments weeks and weeks out; they don’t need phone calls from people.

The best stuff to do is grass roots, ground level. You can go onto our website and find a Please Carry True Blue form there and that sort of thing can help out.

You know what, it’s surprising sometimes, we go and we print those things off when they come back in. We get comments where people have seen the product and want the product, we print them off. People give us notes on our website, even, so if you go on TrueBlue.com and say, “Look, I’m from so-and-so and we want it here,” we give that to the sales people and they present that to the buyers in aggregate when they go in. So there’s all sorts of things that help at some level.

In the Northeast we set up a contract sales network three months ago or so. Don’t sue me if it was four. And we’ve gone into A&P stores in the Northeast now. We have about three other significant chains that we are just going through the listing process with so I’m not going to get into the details of that yet. Probably in the next call we’ll have some conversation about that.

The most important thing is these chains, and it was a lesson learned by us over the last couple of years, is we went in and we got into a lot of chinks. What happened was they would promise to fulfill our minimum order requirements. Then they would come to us and say, “We’re only a chain of 8 stores,” or 20 stores or 40 stores. It was very difficult, unless we had a third party wholesaler distribute those accounts to cost-effectively deliver the size of the orders that would be generated by an 8-store chain. There are plenty of situations like that.

So we’ve gone back and we’ve re-built up more efficient distribution channels that allow us to get in there because we now understand better the order patterns and what it takes and the number of stores, the number of skews, it takes to actually make money going into those places. So, yes, it was a learning experience for us and that’s why you’ve seen some in and out in some of those stores. But where it makes sense and we can get somebody to deliver them and it can be a cost-effective strategy to do so, then you’ll see us back in those places.

George Mazenski – Private Investor

And the other question, I’m looking at your consolidated statement of losses deficit. Under expenses, under other income, you had a reported loss of $1.2 million in May 31, 2007, and only $14,000 in May 31, 2008. What’s the difference?

Ralph D. McRae

The difference is the Hansen’s buyout.

Operator

Your next question comes from Gregg Colburn with Interlachen.

Gregg Colburn - Interlachen Capital

Two questions. First, is there any guidance you can give us on the brands? And how they did individually in the quarter? I know they did well overall and we saw a nice growth. Is there any color you provide there? If not, we understand.

Second question is just on the NASDAQ listing issue, could you give us a little guidance on how the company plans to deal with that?

Ralph D. McRae

Sure. I don’t break out the plans on the growth or any detail on the brands. I can go back, once this conference call is over, and I go back and look at the list of the people who called, and listen to the call, I can identify maybe two or three people who are industry people who listened to this call.

I’m not giving out that type of information that will be competitively used against us. I’m sure there’s somebody on this call right now that knows who I’m talking about so I say this with a bit of my tongue in cheek, but who urged me to put out information about listings. I thought it in my own head for a long time, I put it out, and we then had activity where competitors went in and tried to bounce us off those listings in advance of the stuff actually being on the shelf and delayed us, in some cases, getting into some of those places. Now, we have effectively dealt with that.

It is a competitive business and we want to not be burdened by the fact that we’re in a public company environment where we have to give out certain information. I’m sorry to not give you an answer to your question.

As far as the NASDAQ listing is concerned, really very simply, we have sold some [inaudible] in December to trade above $1.00 for a certain number of days, and then there’s a discussion period that goes on with NASDAQ.

Personally, I’ve been through this before, I’ve been through it in circumstances where market conditions were akin to what we’re going through now. I understand this company and where we’re going. I don’t foresee this to be a problem. I understand how important the NASDAQ listing is to everybody out there; as a shareholder and a manager to this company, it is an important issue to me, too, and I believe it will resolve itself favorably before us. But that’s all I can say.

There is a significant period of time that you’re given to correct this because we are compliance with all of our other minimum listing obligations.

Gregg Colburn - Interlachen Capital

Just so I understand what you just said, are you basically saying you feel pretty good that you’ll get to that dollar price within the time period that the NASDAQ gives you? Is that what you were saying?

Ralph D. McRae

Yes, unless there’s something unforeseen that comes up. But I am extremely surprised, as well as ultimately disappointed, that the stock is at the price that it’s at now. And there’s certain things that we have been reticent, we decided last year we want to show people what we’re doing, we don’t want to talk in advance of what we’re doing, so I think this is a first positive step here on what we’ve done. I went out of my way today to try to explain that we’re not sitting around in la-la-land looking at, “Oh, gosh, the economy is going to recover and everything is going to be fine.”

We are planning for a darker end of the economic spectrum than many people would prognosticate right now and we think that we’re well set to deal with that. I’m not sure that other people in this industry share my view or see the need to follow suit, and I think that that will play to our favor as we go forward. So, I think, plan for the worst and hope for the best. I think we’ll be fine.

Operator

Your next question comes from Geoffrey Aronson with Consensus Partners.