For an up-close look at the impact that a dependence on a few customers can have on a business, look no further than today's news from Monterey Pasta (NASDAQ:PSTA). This morning the food maker said a sharp decrease in orders from its two biggest customers has the company at risk of reporting a net loss for the quarter ending this month -- potentially ending a string of 25 consecutive quarterly profits.
Monterey, examined from certain angles, has the look of a nice little company. (We looked at one of its larger competitors, American Italian Pasta (NYSE:PLB), a few years back.) Over the four full years ended December 2002, it has grown revenues by 25% annually and gross profit and operating income by 20% and 30%, respectively. The balance sheet is free of long-term debt, and the business has generated free cash flow in four of the last five calendar years.
But it's also heavily dependent on just a few customers. Costco (NYSE:COST) grew to represent half of total revenues in 2002, while Wal-Mart (NYSE:WMT) -- primarily the Sam's Club chain -- has accounted for approximately 30% of sales in each of the last three full years. (Grocery chains, including Albertson's (NYSE:ABS) and Kroger (NYSE:KR), are also customers.)
This should come as news to no one -- it's clearly explained in the company's annual report. Perhaps more importantly, today's news was also somewhat foretold in past financial filings. In the most-recent quarterly report, Monterey said Costco sales fell partly because of an overall reduction in refrigerated items in its stores -- though, strangely, Sam's Club sales fell even as Monterey was getting more items and more shelf space in the Wal-Mart chain.
Now the company says Costco sales will fall as much as 35% for the quarter, as storewide item reductions make it difficult to maintain shelf space and, perhaps more importantly, add the new items food companies are constantly developing to boost margins. Sam's Club sales, meanwhile, are expected to fall as much as 6% for the quarter.
Monterey is pointing to some signs of good news. Recent sales to Sam's Club are up from a year ago and the company is looking for a 7% to 10% revenue pop from last year's fourth quarter. This, based on "current trends, assumes retention of current customers, placement of new items in existing stores, and the addition of new retail stores or shelf space." New retail packaging is also being counted on to help.
Even so, investors with both financial and academic interests in this company should watch the story at Costco and Sam's Club closely to see whether Monterey is able to reverse two quarters of very disappointing results and news from its two largest customers -- especially with the food industry consolidating, making things difficult for smaller players.
