Seneca Foods - 10-Q quarterly report FY2015 Q3

Seneca Foods Corporation (the "Company") is a leading provider of packaged fruits and vegetables, with facilities located throughout the United States.  The Company's product offerings include canned, frozen and bottled produce and snack chips.  Its products are sold under private label as well as national and regional brands that the Company owns or licenses, including Seneca®, Libby's®, Aunt Nellie's®, READ®, and Seneca Farms®.  The Company's canned fruits and vegetables are sold nationwide by major grocery outlets, including supermarkets, mass merchandisers, limited assortment stores, club stores and dollar stores.  The Company also sells its products to foodservice distributors, industrial markets, other food processors, export customers in over 80 countries and federal, state and local governments for school and other food programs.  In addition, the Company packs Green Giant®, Le Sueur® and other brands of canned vegetables as well as select Green Giant® frozen vegetables for General Mills Operations, LLC ("GMOL") under a long-term Alliance Agreement.

The Company's raw product is harvested mainly between June through November. The Company experienced unfavorable growing conditions related to our pea and green bean harvest this summer reflecting a combination of high temperatures and uneven moisture.  These difficult growing conditions unfavorably impacted pea and green bean crop yields and plant recovery rates which resulted in unfavorable manufacturing variances.

Investment—In April 2014, the Company purchased a 50% equity interest in Truitt Bros. Inc. ("Truitt") for $16,308,000.  The purchase agreement grants the Company the right to acquire the remaining 50% ownership of Truitt in the future under certain conditions.  Truitt is known for its industry innovation related to packing shelf stable foods in trays, pouches and bowls.  Truitt has two state-of-the-art plants located in Oregon and Kentucky.

Third fiscal quarter 2015 results include net sales of $456,207,000, which represents a 4.5% decrease, or $21,487,000, from the third quarter of fiscal 2014.  The decrease in sales is attributable to a sales volume decrease of $32,317,000 partially offset by higher selling prices/sales mix of $10,830,000.  The decrease in sales is primarily from a $12,377,000 decrease in Canned Fruit sales, an $8,326,000 decrease in Canned Vegetable sales, and a $4,965,000 decrease in Frozen sales, partially offset by $3,417,000 increase in GMOL sales and a $751,000 increase in Other sales. The Canned Fruit sales decrease is primarily as a result of the second short pack in a row.

Nine months ended December 27, 2014 include net sales of $1,008,411,000, which represents a 3.6% decrease, or $38,038,000, from the first nine months of fiscal 2014.  The decrease in sales is attributable to a sales volume decrease of $70,494,000 partially offset by higher selling prices/sales mix of $32,456,000. The decrease in sales is primarily from a $23,200,000 decrease in Canned Fruit sales, a $16,267,000 decrease in GMOL sales and a $6,968,000 decrease in Frozen sales partially offset by $4,057,000 increase in Canned Vegetable sales and a $3,778,000 increase in Other sales.

The following table presents sales by product category (in millions):

Operating Income:

The following table presents components of operating income as a percentage of net sales:

For the three month period ended December 27, 2014, the gross margin decreased from the prior year quarter from 6.5% to 5.7% due primarily to lower net selling prices in the current year as compared to the prior year.  The LIFO charge for the third quarter ended December 27, 2014 was $5,315,000 as compared to $7,676,000 for the third quarter ended December 28, 2013 and reflects the impact on the current quarter of the current reduced inflationary cost increases expected in fiscal 2015, compared to fiscal 2014.  On an after-tax basis, LIFO reduced net earnings by $3,455,000 for the quarter ended December 27, 2014 and $4,989,000 for the quarter ended December 28, 2013, based on the statutory federal income tax rate.

For the nine month period ended December 27, 2014, the gross margin decreased from the prior year period from 7.0% to 5.9% due primarily to lower net selling prices (after considering promotions) compared to the prior year, partially offset by a lower LIFO charge in the current year as compared to prior year.  The LIFO charge for the nine months ended December 27, 2014 was $10,885,000 as compared to a charge of $22,111,000 for the nine months ended December 28, 2013 and reflects the impact on the nine months of decreased inflationary cost increases expected in fiscal 2015, compared to fiscal 2014.  On an after-tax basis, LIFO decreased net earnings by $7,075,000 for the nine months ended December 27, 2014 and decreased net earnings by $14,372,000 for the nine months ended December 28, 2013, based on the statutory federal income tax rate.

For the three month period ended December 27, 2014, selling costs as a percentage of sales decreased slightly from 2.4% to 2.3% from the same period in the prior year.  For the nine month period ended December 27, 2014, selling costs as a percentage of sales remained unchanged at 2.7% from the same period in the prior year.

For the three month period ended December 27, 2014, administrative expense as a percentage of sales was unchanged at 1.8% compared to the same period in the prior year.  For the nine month period ended December 27, 2014, administrative expense as a percentage of sales increased from 2.2% for the third quarter ended December 28, 2013 to 2.3%.  Administrative expense increased for the nine month period ended December 27, 2014 as a percentage of sales due primarily to lower net sales in the current year as compared to the same period in the prior year.

During the third quarter of fiscal 2015, the Company recorded a restructuring charge of $889,000 related to the closing of a plant in the Midwest of which $533,000 was related to severance cost, $316,000 was related to equipment costs (contra fixed assets), and $40,000 was related to estimated equipment relocation costs.  This charge is included in restructuring in the Unaudited Condensed Consolidated Statements of Net Earnings.

During the quarter ended December 27, 2014, the Company recorded a gain of $5,000,000 related to a contractual payment received in connection with the closing of a Midwest plant (see Note 8 above).  During the nine months ended December 27, 2014, the Company recorded a charge of $250,000 for environmental costs related to a Company-owned plant in New York State.  During the nine months ended December 27, 2014, the Company sold some unused fixed assets which resulted in a gain of $89,000.  During the nine months ended December 28, 2013, the Company sold some unused fixed assets which resulted in a gain of $423,000.  These gains are included in other operating income in the Unaudited Condensed Consolidated Statements of Net Earnings.

Interest expense for the three months ended December 27, 2014, as a percentage of sales, remained unchanged at 0.3% from the three months ended December 28, 2013.  Interest expense for the nine months ended December 27, 2014, as a percentage of sales, decreased from 0.5% to 0.4% from the third quarter ended December 28, 2013. This decrease was due to lower interest expense related to the Company's Revolver and decreased long-term debt interest attributable to scheduled debt payments.

The effective tax rate was 24.6% and 9.3% for the nine month periods ended December 27, 2014 and December 28, 2013, respectively.  The 15.3 percentage point increase in the effective tax rate represents an increase in tax expense as a percentage of book income when compared to the same period last year.  The major contributors to this increase are first the re-establishment of the valuation allowance related to the New York State Investment Tax Credit (5.9 percentage points).  The valuation allowance was re-established due to a change in the law. This is a discrete item and therefore was required to be booked in the quarter ended June 28, 2014.  Secondly, the expiration of the California enterprise zone credit and the California hiring credit (4.9 percentage points).

The financial condition of the Company is summarized in the following table and explanatory review:

Note: Equivalent common shares are either common shares or, for convertible preferred shares, the number of common shares that the preferred shares are convertible into.  See Note 8 of the Notes to Consolidated Financial Statements of the Company's 2014 Annual Report on Form 10-K for conversion details.

As shown in the Condensed Consolidated Statements of Cash Flows, net cash used in operating activities was $18,505,000 in the first nine months of fiscal 2015, compared to net cash provided by operating activities of $12,570,000 in the first nine months of fiscal 2014.  The $31,075,000 decrease in cash provided is primarily attributable to a $24,746,000 higher increase in inventory in the first nine months of fiscal 2015 as compared to the first nine months of fiscal 2014, a $12,821,000 decrease in the cash provided by Accounts Payable, Accrued Expenses and Other Liabilities, a $4,587,000 decrease in cash provided by accounts receivable, decreased net earnings of $7,662,000 as previously discussed, partially offset by a $13,508,000 decrease in cash used by other current assets, and a $5,569,000 decrease in cash used by income taxes.

As compared to December 28, 2013, inventory decreased $3,574,000 to $547,149,000 at December 27, 2014.  The components of the inventory decrease reflect a $39,029,000 decrease in finished goods, a $12,251,000 increase in work in process and a $23,204,000 increase in raw materials and supplies.  The finished goods decrease reflects lower inventory quantities and decreased sales volume as compared to the prior year.  The raw materials and supplies increase is primarily due to an increase in cans and raw steel quantities compared to the prior year.  FIFO based inventory costs exceeded LIFO based inventory costs by $164,269,000 as of the end of the third quarter of 2015 as compared to $155,126,000 as of the end of the third quarter of 2014.

Cash used in investing activities was $35,214,000 in the first nine months of fiscal 2015 compared to cash used in investing activities of $11,062,000 in the first nine months of fiscal 2014.  Additions to property, plant and equipment were $19,232,000 in the first nine months of fiscal 2015 as compared to $12,058,000 in the first nine months of fiscal 2014.  In April 2014, the Company purchased a 50% equity interest in Truitt Bros. Inc. for $16,308,000.

Cash provided by financing activities was $62,886,000 in the first nine months of fiscal 2015, which included borrowings of $326,381,000 and the repayment of $248,110,000 of long-term debt, principally consisting of borrowing and repayment on the revolving credit facility ("Revolver").  Other than borrowings under the Revolver, there was no new long-term debt during the first nine months of fiscal 2015.  During the nine months ended December 27, 2014, the Company repurchased $9,201,000 of its Class A Common Stock as treasury stock.  In addition, the Company paid down Notes Payable of $6,266,000 during the nine month period ended December 27, 2014 related to some interim notes which became operating leases.

Available borrowings on the Revolver total $300,000,000 from April through July and $400,000,000 from August through March with a maturity date of July 20, 2016.    The interest rate on the Revolver is based on LIBOR plus an applicable margin based on excess availability and the Company's fixed charge coverage ratio.  As of December 27, 2014, the interest rate was approximately 1.91% on a balance of $255,000,000.  We believe that cash flows from operations, availability under our Revolver and other financing sources will provide adequate funds for our working capital needs, planned capital expenditures, and debt obligations for at least the next 12 months.

The Company's credit facilities contain standard representations and warranties, events of default, and certain affirmative and negative covenants, including various financial covenants.  At December 27, 2014, the Company was in compliance with all such financial covenants.

Refer to footnote 9 of the Notes to Condensed Consolidated Financial Statements.

The Company's revenues are typically higher in the second and third fiscal quarters. This is due in part because the Company sells, on a bill and hold basis, Green Giant canned and frozen vegetables to GMOL at the end of each pack cycle, which typically occurs during these quarters.  GMOL buys the product from the Company at cost plus a specified fee for each equivalent case.  See the Critical Accounting Policies section below for further details.  The Company's non-Green Giant sales also exhibit seasonality with the third fiscal quarter generating the highest retail sales due to holidays that occur during that quarter.

During the nine months ended December 27, 2014, the Company sold $138,034,000 of Green Giant finished goods inventory to General Mills Operations, LLC ("GMOL") for cash, on a bill and hold basis, as compared to $150,345,000 for the nine months ended December 28, 2013.  Under the terms of the bill and hold agreement, title to the specified inventory transferred to GMOL.  The Company believes it has met the revenue recognition criteria required for bill and hold treatment.

Trade promotions are an important component of the sales and marketing of the Company's branded products, and are critical to the support of the business. Trade promotion costs, which are recorded as a reduction of net sales, include amounts paid to encourage retailers to offer temporary price reductions for the sale of our products to consumers, amounts paid to obtain favorable display positions in retailers' stores, and amounts paid to retailers for shelf space in retail stores. Accruals for trade promotions are recorded primarily at the time of sale of product to the retailer based on expected levels of performance. Settlement of these liabilities typically occurs in subsequent periods primarily through an authorized process for deductions taken by a retailer from amounts otherwise due to us. As a result, the ultimate cost of a trade promotion program is dependent on the relative success of the events and the actions and level of deductions taken by retailers for amounts they consider due to them. Final determination of the permissible deductions may take extended periods of time.

The Company assesses its long-lived assets for impairment whenever there is an indicator of impairment. Property, plant, and equipment are depreciated over their assigned lives. The assigned lives and the projected cash flows used to test impairment are subjective. If actual lives are shorter than anticipated or if future cash flows are less than anticipated, a future impairment charge or a loss on disposal of the assets could be incurred. Impairment losses are evaluated if the estimated undiscounted value of the cash flows is less than the carrying value. If such is the case, a loss is recognized when the carrying value of an asset exceeds its fair value.

In the ordinary course of business, the Company is exposed to various market risk factors, including changes in general economic conditions, competition and raw material pricing and availability.  In addition, the Company is exposed to fluctuations in interest rates, primarily related to its revolving credit facility.  To manage interest rate risk, the Company uses both fixed and variable interest rate debt.  There have been no material changes to the Company's exposure to market risk since March 31, 2014.

The Company maintains a system of internal and disclosure controls and procedures designed to ensure that information required to be disclosed in reports filed or submitted under the Securities Exchange Act of 1934, as amended, is recorded, processed, summarized and reported on a timely basis. The Company's Board of Directors, operating through its Audit Committee, which is composed entirely of independent outside directors, provides oversight to the financial reporting process.

An evaluation was performed under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rule 13a-15(e) under the Securities and Exchange Act of 1934, as amended) as of the end of the period covered by this report.  Based upon that evaluation, the Chief Executive Officer and the Chief Financial Officer concluded that, as of December 27, 2014, our disclosure controls and procedures were effective.  The Company continues to examine, refine and formalize its disclosure controls and procedures and to monitor ongoing developments in this area.

There have been no changes during the period covered by this report to the Company's internal control over financial reporting that has materially affected, or is reasonably likely to materially affect, the Company's internal control over financial reporting.

Pursuant to the requirements of the Securities Exchange Act of 1934, the Company has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

January 28, 2015
                                                                                                                                                                                                Kraig H. Kayser