John B Sanfilippo & Son Inc (JBSS) 2004 Q3 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Third Quarter 2004 John B. Sanfilippo and Son Earnings Conference Call. My name is [Kelera][ph], and I will be your coordinator for today.

At this time, all participants are in listen-only mode. We will be facilitating a question-and-answer session towards the end of this conference. If you require assistance at any time during the call, please press star, followed by zero, and a coordinator will be happy to assist you.

I would now like to turn the presentation over to your host for today's call, Mike Valentine, Chief Financial Officer. Please proceed, sir.

Thank you.

We want to thank you for participating in our quarterly conference call for the third quarter of fiscal 2004. This call is scheduled for one hour. We apologize for the delay, as there are quite a few people dialing in right now and just a tad overwhelmed a bit.

With us today are Jeff Sanfilippo, Executive Vice President of Sales and Marketing; Jim Barker, Senior Vice President of Sales and Marketing; Bill Pokrajac, Vice President of Finance; and Herb Marros, Controller.

I'd like to start off the call with a few brief remarks about the quarter, and then we'll move to Q&A.

With respect to the income statement, revenue grew 15 percent, from $86.9m to $100m. The primary drivers of the growth were -- there was good growth during the quarter in the snack nut category at grocery, which was up 17 percent on dollars and 15 percent on units, and there's definitely an indication that this growth rate is trending up, as the growth rate over the last 12 months was 15 percent on dollars. Virtually all of our sales increases during the quarter came from increases with existing customers. The sales increase was led by increases in contract packaging at 54 percent and food service at 37 percent. Approximately two-thirds of our sales increase came from higher average selling prices, especially in product types, such as pecans, almonds, and macadamias.

Third quarter sales shifted towards contract packaging and foodservice distribution channels, and with respect to product type, it shifted toward pecans and almonds, in comparison to the sales mix of the third quarter of fiscal 2003.

As we've mentioned before, we have instituted price increases, primarily starting in the private label snack nut area of our consumer distribution channel, and those all went into effect in the first week of April. Our industrial, domestic, and export pricing will remain fixed until we roll out of existing contracts. And I'll let both Jeff and Jim Barker talk a little bit more about the price increase later on in our remarks.

With respect to gross margin, gross margin was 14.5 percent versus 18 percent a year ago as a percentage of net sales, and the drivers of the gross margin change were -- first, there was a mix in our distribution channels, as the sales mix shifted toward contract packaging, and contract packaging did outpace overall growth and just brought down our margin percentage. So this decline from this shift was partially offset by a substantial increase in our gross margin in the contract and packaging distribution channel.

Gross margins declined on all nut types, led primarily by cashews, peanuts, mixed nuts, and almonds. This was due mostly to a high level of spot purchases of these particular nuts in the month of March, as we needed to fill in some gaps due to the increasing demand for the nuts that we produce.

A sales shift away from mixed nuts, which typically have the highest gross margin percentage, to pecans and almonds also contributed to the increase in gross margins.

Following our quarterly physical inventory, which we take at the end of every quarter and at year-end, we chose to lower the estimate of our bulk almond inventory by approximately $550,000, which took us from a 15-percent gross margin to a 14.5-percent gross margin. We routinely re-estimate the inventories of all our bulk fungible stored raw materials at the end of every quarter.

Markets are continuing to rise, especially with respect to imported nuts, which primarily go into our private label snack nuts. The private label increases that we're going to talk about in a little bit went into effect in the first week of the fourth quarter, and these increases will help the [drag][ph], the gross margin decline, especially on mixed nuts and cashews.

In respect to selling and administrative expenses, they fell from 13.8 percent of net sales to 11.1 percent of net sales, or declined by $1.1m. This was a result of, first, we had unusually high audit/legal costs in the third quarter of fiscal 2003 due to the establishment of certain litigation reserves in that quarter, which have been subsequently settled. Also, lower incentive compensation expense in the current quarter led to the dollar decline in administrative expenses.

Selling expenses held steady in dollar terms and fell from 9.6 percent of net sales to 8.5 percent of net sales, mainly due to leverage.

Operating income was $3.4m, versus $3.7m in the third quarter of fiscal 2003, and as a percentage of net sales, it compared as 3.4 percent versus 4.2 percent in the third quarter fiscal 2003, and this was, of course, due to the gross margin decline, which was offset by a decrease in selling and administrative expenses.

Net income was essentially unchanged versus the third quarter of 2003 after taking into account a reduction in interest expense, which resulted from lower debt levels during the quarter.

Fully diluted earnings per share were down one cent per share due to share count increase, which was up by 237,000 shares. The share count increased primarily because of exercised options during the quarter and also the effect that a significantly higher share price had on unexercised options during the quarter.

With respect to the balance sheet, just a few highlights. We ended the quarter with $76.6m of interest-bearing debt versus $85.7m of interest-bearing debt in the third quarter of 2003 and $52.3m in the second quarter of fiscal 2004, primarily due to long-term debt payment.

Inventories are at record levels at $152m. They're at these high levels to position us to take advantage of the increasing demand for nuts that we expect to see this summer and also to take advantage of new opportunities that will arise over the next two quarters. We expect our inventories to decline rapidly over the next few quarters.

Accounts receivable were up 13 percent over the third quarter of last year, tracking with the sales increase, but we do want to note that our DSO, despite the increase, fell by about 6 percent versus the third quarter of '03.

And then, finally, on the liabilities side, we want to point out that we did reclassify a sizable amount of our long-term debt to current, as we intend to prepay our long-term debt with the proceeds of the offering.

A quick update on the facility consolidation project that we've talked about and mentioned in our prospectus. We are near the completion of our site-selection process. Our building plans are also nearing completion, and we still continue to expect that we will break ground on the new facility this fall.

At this point, I'd like to turn the remarks over to Jeffrey Sanfilippo, and he'll talk about some of the significant events during the quarter and other sales and marketing matters.

Okay, great. Thank you, Mike.

As Mike had mentioned, we saw a little bit of a shift in our consumer channel, our foodservice, industrial, substantial growth in both the foodservice channel, as well as the contract packaging channel.

Mike also mentioned -- talked about the price increase, which was just implemented in the beginning of April, and we're just now going to start seeing the effects of that. Not only did we take the increases in the consumer channel, but we also took some price increases in the foodservice channel. Foodservice is really a 30-day lookout as far as price changes. That's the kind of notification we give our foodservice customers, and we did take price increases this past quarter, which go into effect now.

Jim, do you want to elaborate a bit on the consumer side?

On the consumer, private label price increases did go into effect on April 5 across all of our customers. We're starting to see the impact -- or we will see the impact of that in Q4. It was in the target area of about an 8-percent increase, as we've previously discussed, and we've also, you know, made sure that all that is taken care of, and we've kept the promotional activity on private label, as well as [Fisher] through the third quarter and into the fourth quarter to make sure that we capitalize on, you know, the growth trends and the opportunities that the retail or partners have presented to us that will allow continued growth.

Talk about the success of the foodservice channel specifically -- as we've talked about in the past, we're seeing an increase in the foodservice channel sales sector, picking up some new distribution with companies like Cisco and U.S., but really it's just incremental growth as the foodservice channel gains more of the food dollars spent in the industry.

As far as the contract packaging, the substantial growth there was with our major customer in that channel, launching a new product line in the snack nut category.

And the other exciting developments in the third quarter -- the FDA announced the walnut health claim just the last couple of weeks, basically validating the health claim that has been talked about, and you'll see a substantial increase in promotions in this new health -- FDA [indiscernible] packaging in the future, which we expect to continue to drive growth of the snack category.

Overall in the category, we still see consistent 14- to 16-percent growth in the snack category, and baking is right behind there, a substantial growth in the baking sector.

So we're very optimistic going forward into our fourth quarter, seeing strong results across all of our product lines.

Some of the new accounts that we've talked about and developed over the last year are starting to hit. McDonald's, for example -- their successful salad launch of a new product line that will include walnuts. They continue to expand the number of stores that that product will be sold to in hopes of going into a national rollout in 2005.

Okay, thanks, Jeff. Just to conclude before we go to Q&A, we continue to be very optimistic about our prospects for growth. We continue to see in the early part of this quarter sizable increases in consumption of nuts, and that goes for our sales, too.

Also, we want to remind all of our investors that commodity markets, specifically, nut commodity markets, are rising, in some cases, rising very rapidly due to the increasing worldwide demand for nuts. And these price increases that we talked about will be very important in respect to our ability to maintain our margins over the next two quarters.

At this point, we would turn it over to Q&A. We'll gladly take any questions you have.

Operator, would you please queue up the first question?

Certainly. [Caller instructions.]

Your first question comes from the line of [Scott Van Winkle][ph] with Adams, Harkness.

[Inaudible] a few questions. First, on the price increase, the 8 percent you mentioned on private label, is that a blended rate? Is that consistent across all the product categories? And if so, should I assume that private label's, you know, 40 percent of your business, that we're talking about, you know, broadly over a 3-percent price increase across all of your business? Is that the right way to think about it?

Yes.

Okay. And, second, Mike, how are you going to work going forward to manage commodity cost? I don't think there's any hedging you can do. You know, how far forward do you buy? What can you do to avoid having to make purchases during the quarter that are higher levels?

Well, most of the purchases that I referred to during the quarter that we had to do in March were really more gap-filling-type purchases and primarily on imported nuts. And some of the reasons that occurs is that, especially as markets increase, some of the origins, which are primarily Third World origins, tend to delay their shipments and take advantage of the increasing market. When they do that, we do have to bring in additional inventories out of the spot market to carry on. In most cases, we'll get those nuts. They may be delayed by a month or two, but we'll still be able to take advantage of those lower-cost nuts in future quarters.

And with the ending inventory adjustment, is this a common problem in Q3 because of the high inventory levels?

Q3 is a key quarter for inventory adjustments, especially on bulk fungible raw materials. In Q1 and Q2, a significant amount -- almost all of the raw materials that we buy that we shelve are being received and also being used, so there's a lot of activity. That all settles down after December, and certainly by March, all of our receiving is completed. And it gives us a good opportunity to step back and take a hard look at the inventory for the nuts that we shelve.

Okay, and one back to the price increase. What was the magnitude of the price increase in foodservice, and how much of your foodservice business does it cover?

Just about [indiscernible] percent as well in the foodservice channel. It probably covers probably similar to what we're doing in consumer. I mean if you look at -- I mean, clearly, your mixed nuts, your cashews, almonds, as well, in the foodservice channel, so probably maybe 30 percent, 30 percent of the business.

Okay, thank you.

Your next question comes from the line of [Patrick Winton][ph] with [Stern and Leech][ph]. Please go ahead.

Thanks. Hey, guys, one question on the delays coming from your suppliers, or we'll call it a default rate. Is there any sort of rate that we can apply to that? I mean is it more of a one-off situation where we can pretty much count on that type of behavior from suppliers in this environment?

In this environment, we'll see that sort of behavior over the next, you know, two to three quarters. It's difficult to predict what will happen. We're certainly -- we've been through this before many times. I think this time we're probably in a much stronger position because we are one of the largest cashew users in the world, and certainly there's a lot of reputable packers out there that do not want to get on our so-called "black list." They may ask us for help in delaying shipment. They may ask us to average out some price increases in the future against some of the lower price deliveries that they're going to make now, and we'll work with them to do that, and that's not unusual to do that in these circumstances.

Talk about the plans kind of for promotional spending for branded product for this upcoming quarter, the rest of the year, and also, just touch on kind of the changes going on in labeling and highlighting the health benefits of nuts -- low carbs, etcetera.

All right. As far as labeling and the low-carb qualified health claims, we have plans in place. We have already started to put the qualified health claims out on the Fisher packaging, and we're working with our private label customers to put the qualified health plan on there as well. Private labels take the much longer time because it's a by-customer decision. And we're also working on the net carb statement. We're incorporating qualified health plan in some of the trade, as well as a direct-to-consumer advertising that we've done through SSI coupons and image advertising as well. So that's what we're doing to get the health benefits out to the consumers, to the retail trade.

As far as the promotional advertising spending, we're seeing the same frequency that we would've last Q4, but it is at a slightly lower spend than we did a year ago.

Okay. And then, lastly, in terms of the price increases, can you comment on the competitive landscape and what you're seeing out there in terms of the effectiveness of this -- of raising your prices at this point?

Well, it's not easy, but it's being done by us as well as our competition on the private label across the board side, and then we're also seeing some activity on the branded side from the brand leader. And we fully expect that, you know, any time you take a price increase, it's going to be difficult, but we're able to justify it, and we try to get out ahead of it enough where we have time to work it through with all of our customers and make sure that they understand it and also accept it.

So essentially, you're not alone in raising prices? Everyone across -- your competitors are raising prices as well?

That is correct.

Okay, thanks.

[Caller instructions.] Your next question comes from the line of Scott Van Winkle with Adams, Harkness. Please go ahead.

Hi, I hate to keep harping on this price increase, but Mike, just -- I want to make sure my math is right here. If I assume, and based on the numbers you gave me about private label price increase in foodservice, it would come out to like a 3.5-percent increase across your entire sales. If I apply that to your third quarter sales just reported, your gross margin would've been down about 20 basis points year over year, excluding the half a million dollars. Is that the right -- I mean so it's almost offsetting all of the price increase? Is that the right -- all of your price at your commodity price increases? Is that the right type of assumption?

Well, for the third quarter, that probably doesn't work that well because there is a significant amount of industrial sales made in that quarter which are not affected by the sales increase.

Okay.

And just to kind of give you an idea how that works out, in the third quarter, consumer made up roughly 48 percent of our sales. Industrial made up, you know, roughly 24 percent of our sales; foodservice, 12; export, 8; and contract packaging, 8. And you compare that to where we were at year-end 2003 --

Industrial was 21 percent; consumer was 57.

So you can see, it's dramatically different from what you see for a whole year.

Okay.

So, you know, that math doesn't work perfectly when you do that.

Okay, so it offsets most of it but not quite all of it, so we should still assume a little bit of gross margin pressure going forward?

Right. Now, the good news is, you know, going into the fourth quarter, we're going to start to shift back to consumer and away from industrial. I mean you get a lot of industrial sales in the first quarter because they're gearing up for ice cream season.

Okay.

So, you know, that'll help those dynamics.

Okay, and any comments on the trends? I know it's early to date in the June quarter.

Well, I'll also let Jim talk a little bit about the categories here, but, you know, certainly what we've seen in the first three weeks in terms of top-line growth, we're very pleased with what we see so far.

You know, one of the things I also want to stress, when I compare the third quarter to all the other quarters, it's not unusual for consumers to take a break from nuts after the Superbowl, and considering that they really have consumed a lot of nuts and more so in our second quarter than ever before. So you get a bit of a drop-off on the growth rate, but [indiscernible] that always come back, especially on the consumer side, in the fourth quarter.

And when you look at just the trailing 13 weeks for AC Nielsen, the snack nut category just in the food channel was up 16.7 percent. If you compare that to the past 12 months of 14.9, we're seeing acceleration on a dollar sale basis in the food channel. So we expect that to increase during Q4, and we expect to, you know, see our brands and private label follow suit.

In the industrial channel, we continue to see double the amount of R&D projects that we're currently working on for really value-added type of pecans, almonds, walnuts, macadamia, and we expect that to continue and we see it continue; same in the foodservice channel. Working with a lot of new projects with some of the major distributors and [indiscernible] for new recipes, and they continue to come to us looking for new product lines.

Thanks.

[Caller instructions.]

It appears there are no further questions at this time, gentlemen. Please proceed with your closing remarks.

Okay. This concludes our call. We thank you again for your participating in our call and your interest in our company. As we mentioned before, we're still very optimistic about the trends in our industry and also how that will benefit our company, and we look forward to getting back together again at the end of our fourth quarter. Thanks again for joining us.

Ladies and gentlemen, thank you once again for your participation in today's conference. This concludes the presentation. You may now disconnect.