John B Sanfilippo & Son Inc (JBSS) 2005 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the second quarter 2005 John B. Sanfillippo and Sons earnings conference call. My name is Raika and I will be your coordinator for today. At this time all participants are in a listen-only mode. We will be facilitating a question/answer session towards the end of this conference. If at any time during the call you require assistance 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, Mr. Michael Valentine CFO, please proceed, sir.

Thank you, first we'd like to thank everyone for participating in our quarterly conference call for the second quarter of our fiscal 2005. Before we start we want to remind everyone that we may make some forward-looking statement today. These statements are based on our current expectations and involve risks and uncertainties. The factors that could negatively impact our results are explained in our various SEC filings that we've made. We encourage you to these filings to learn more about these risk factors. Starting with the income statement, quarterly net sales grew 70 percent from $183 million from $171 million. The primary drivers of the growth were: first we saw substantial increases in industrial, food service, export, and contract packaging distribution channels that ranged between 15 and 40 percent. These gains were offset by a decrease in sales in our consumer channel of approximately two percent which resulted primarily from lower promotional activity for Fisher peanut products at a major customer and that's the same promotion we referred to in the first quarter. Sales increases primarily came from higher average selling prices. Sales in the quarter were up on pecans, almonds, and mixed nuts, all of which delivered lower gross profit dollars than they did in the second quarter of fiscal 2004. Year-to-date net sales grew again by seven percent to -- to almost $318 million from $297 million. This increase is attributed to growth in the industrial, food service, export, and contract packaging distribution channels, and those growth ranges between 13 percent and 45 percent and they were offset by a three percent decrease in net sales generated through the consumer channel. Again, the sales increases were generated primarily by higher average selling prices and sales were up on pecans, almonds, and mixed nuts, again, all of which delivered gross profit dollars than they did for the first two quarters of fiscal 2004. Second quarter gross profit margin declined to 13.7 percent from 19. 2 percent in the second quarter of fiscal 2004. The decline in gross margin can be attributed to higher costs for pecans that were used to fulfill our obligations on remaining industrial contracts that were priced approximately a year ago during the old crop. Higher tree nut costs that were not passed on to customers in the consumer channel until January of 2005 also contributed to the decline in gross margin. Further, we wrote down several old crop pecan industrial contracts to net realizable value and that also contributed to a decline in the gross profit margin in the second quarter. Finally, we did see lower margins on almond contracts, especially the old crop almond contracts. The year-to-date gross profit margin declined to 13.2 percent from 19.7 percent a year ago as a percentage of net sales. The decline in gross margin came about as follows: There was a significant increase in the cost of almonds purchased in the spot market during the first quarter of fiscal 2005 as we have discussed before. There was also an unfavorable almond processing variance generated in the first quarter. Again, as you may recall, that was due to low-quality input stocks on the 2003 crop almonds. There was a higher than expected final settlement with almond growers in the first quarter. Walnut yields in shelling were also lower than expected during the first quarter and the gross margin in the first quarter of 2004, as you may recall, did benefit from a sizable gain in pecan shelling that did not occur in the first quarter of fiscal 2005. Quarterly selling and administrative expenses as a percentage of net sales fell from 8.8 percent in the second quarter of '04 to 7.8 percent in the current quarter. Quarterly selling expenses decreased from 6.4 percent to 6.0 percent as a percentage of net sales due to lower employee incentive compensation expenses. And quarterly administrative expenses fell from 2.4 percent to 1.8 percent as a personal of net sales, again, due to lower incentive compensation expense which is tied to earnings per share. Year-to-date selling and administrative expenses fell from 9.4 percent fiscal 2004 to 8.4 percent in the current first two quarters. Year-to-date selling expenses decreased from 6.7 percent to 6.5 percent, and year-to-date administrative expenses fell from 2.7 percent to 1.9 percent. In both cases the reduction primarily is attributable to lower incentive compensation expense. Quarterly operating income fell by approximately $7 million due to the gross margin decline. And year-to-date operating income fell by approximately $15 million, again due to the gross margin decline. Interest expense for the quarter was down by about $439,000 and year-to-date interest expense declined by $1.1 million. And in both cases that was due to lower debt levels compared to those of a year ago. Because of the lower gross margin, quarterly net income decreased by about 38 percent and year-to-date net income decreased by about 49 percent. Taking a quick look at the balance sheet, as you may recall the company in the middle of December entered into a $65 million long-term debt financing agreement. That facility is unsecured, ten years with an average interest rate of 4.67 percent. These funds will be used temporarily to reduce our short-term debt and to use towards working capital, but ultimately it will be used to finance our facility consolidation project. Inventories versus a year ago were up approximately $70 million, or 50 percent, and also up by approximately 11 million pounds, or roughly 11 percent. The dollar increases field of course by higher commodity cost especially with respect to pecans and almonds. At this time I'd like to turn the discussion over to Jim Barker to discuss some of our -- sales in some of our distribution channels.

Thanks, Mike. In the consumer channels, as Mike said, the consumer channel which makes up a large percentage of our business was down for the quarter and remains down for the year. For -- as Mike alluded to, a lot of this was driven by the promotion that we talked about during our conference call in the first quarter that did carry over into the second quarter. Also with executing private label price increases and just putting price increases through, you know, due to the higher commodity and nut costs, we did pass on some sizable pieces of business and actually didn't keep some business in the limited assortment distribution channel. And if you would have taken the promotion, the peanut promotion on Fisher as well as the business we passed on, or didn't keep, due to not getting the prices that we needed, we would have actually been up about 12 percent for the quarter. And the category for the quarter grew about eight percent, so while we're not happy about that, it goes to explain why we remain down for the quarter and why the volume, you know, continued to stay below last year. When you look at the category, it is still growing, but we're seeing some slowing down in the trailing six and three months. When you look at the snack nut category per A.C. Nielsen -- and this is for the most recent period through December 18th -- so it does not have the -- the Christmas and New Year time period, dollar sales were up 13.7 percent in the category for the 52 week period, but then we see the slowing in the trailing six months at 10.2 percent and the trailing three months at 7.8 percent and unit volume followed the same trend. In baking nuts dollars were up 7.9 percent for the 52 weeks, but then for the trailing six and three were only up 4.8 percent and 2.2 percent, and one anomaly with the baking nut category versus snack nuts is unit volume was actually down for the trailing six and the trailing three-month period. We did increase -- we did execute the price increase on private label as we talked about across all retailers. One of the things we expect to begin seeing and are seeing now is some increased prices on private label as well as branded because Planters also took an increase on their tree nuts and seed items. There's a lot of concern out there with the retailers about the increased prices, especially as the gap between private label and the brand leader lessens 'cause it does put some pressure on their margins and also has them actually think a little bit more about their promotional plans and activity. So we expect some of this slow down in growth to continue, but we don't expect it to go down to a no-growth category. And it'll be interesting to see how quickly the retailers do increase retail prices on their private labels specifically, because Planters retail has started to show up ore the last four weeks, and that's the consumer channel. As far as industrial, you know, we continue to work out of some of the, you know, from the contracts that had caused some of the margin decline on almonds and we're outgoing and, you know, we're contracting that in a different and better way for this year, and we've got some new business as we continue to focus in on the top 20 major food manufacturers across the U.S. with value-added nut-type products for products. So, that's the update on industrial and consumer which is our -- which are our two largest channels. I'll turn it back to Mike.

Thanks, Jim. We thank everyone for their interest and their time in our company. We continue to be optimistic about gross margin improvements going forward as we've mentioned before. Hopefully these tree nut markets will stabilize and we can actually show that. And at this time we'd gladly take your questions.

Ladies and gentlemen, If you wish to ask a question please press star followed by one on your touch-tone telephone. If your question has been answered or you wish to withdraw your question please press star followed by two. Please press star, one to begin. Please stand by for your first question. Once again, ladies and gentlemen, that's star, one for questions. Your first question comes from Chuck Kranowski from Key McDonald, please proceed.

Good morning, everyone. Chuck Sarankowski. Mike, I want to just look at this concept here of fulfilling these pecan contracts and other ones. Are you basically saying that the loss that might have taken place in the second half of the year from some of the industrial contracts has been pushed into the second quarter?

That's correct, Chuck.

And have you -- do you still need to expend cash to buy the pecans, for example, or is it just flat out now behind you, cash in the earnings in?

Well, with respect to the earnings hit on old crop industrial contracts, it's for the most part, it's done and behind us. With respect to expending cash on pecans, we're near the end here, and I think, you know, probably the final ten percent needs to be paid for.

Okay. Hey, can you give us the update on the Chicago consolidation project, please?

I'll turn that over to Jasper Sanfilippo, Junior.

We're currently in the process of doing due diligence on a piece of property we bought out in Elgin which has an existing building of 700,000 square foot of manufacturing and 400,000 square foot of office. We expect to close in the middle of March on that property. We're currently working with engineers on doing an addition of about a third into the manufacturing pod to meet our requirements. We're working with realtors in terms of looking at sub-leasing the 400,000 square foot of office. As we mentioned before, we also have run a parallel path with respect to a -- the mental health facility in Elgin, which we've promised the city that we would remedy the environmental clean-up. We're currently working with realtors and developers on spinning that off to compensate for expense in terms of the cleanup. Other than that, we're looking at new equipment and engineering drawings on plant layouts and such to meet our requirements at the Panasonic facility.

Thanks, Jasper.

Thank you.

Thank you, once again, ladies and gentlemen, please press star, one for questions. And your next question comes from Brian Black of Land partners. Please proceed.

Hey everybody, Mike, can you talk a little further about the gross margin issue. If we assume that the tree nut prices or tree nut market does stabilize, which I know is a big "if" and out of your control, what kind of normalized gross margins do you think you can regain.

Well, I'd say probably the most important distribution channel in the context of your question would be the industrial channel. As a general rule, our gross margins on industrial sales are roughly about 10 percent. And we think that as long as prices stay where they are right now, we can hit that gross margin again. And that's a substantial improvement from where we were really over the last two or three quarters.

And can you just remind us what -- obviously promotional activity plays a role, but what a of sort of a typical gross margin would be on the consumer side?

The consumer side when you average branded and private label probably settles anywhere in the high teens to the low 20s.

Right, okay. Great, thanks a lot.

Okay, thank you.

Thank you, and your next question comes from Scott Van Winkle of Adams Harkness. Please proceed.

Adam Sackness, thanks. Mike, can you quantify your impact on the gross margin from your taking the write down on industrial contracts that have yet to be shipped this quarter.

It was less than 100 basis points.

Okay, and if you try to break out the gross margin pressure between the different channels, maybe just focus on industrial, you talk about a 10 percent target for your industrial gross margins, what was it this quarter? Was it five? Was it lower than that?

I would say it's probably at best five.

Okay, so -- I mean that's a big piece of it then?

Yeah, and it's basically consistent with what we've been saying.

Okay. And I guess this is probably for Jim, but what are your competitors doing out there on the consumer side on the private label? You mentioned Washington away from some contracts. Are your competitors not being as aggressive with taking a price? Just a little more of a dynamic there.

Well, I think, you know, what we've seen is that while everyone has taken a price increase, not everyone has taken it to the level that we feel we needed to to restore and maintain margin, and we had to walk from some limited assortment business. Now, one interesting thing is that there are competitors out there that, while they are priced lower than us today, will not take additional business where we split the business. We've seen that with a couple of customers, especially as it relates to baking nuts, and I think what's happened is is that our competitors may not -- and "may" being the operative word -- may not have realized how high some of these commodity costs have gone. And that's why, you know, our prices have continued to stick. But there are some lower price sellers out there that have cost us to make the right decision -- we feel for margin and profit -- not to do that business. You know, some good things, though, looking forward is you look at that retail promotion that our largest customer that, you know, continued to be down, we are going to see an uptick in that in the third and fourth quarters as we spread some of those cases out, it looks like. So some of that should be coming back, but we will not make up 100 percent of that promotion volume loss on the Fisher brand this year, but we'll make up a good chunk of it still.

And do you think the slowing growth in the snack nut category -- do you think it's a function of price? I mean are we seeing the same thing here that we saw with macadamias where prices got so high the consumer finally just walked away.

Well, I think -- I don't think we're really saying the prices out there yet. I mean when you look at this, Scott -- when you look at Nielsen data, like in the last 12 months, six, and three on baking nuts, prices are only up about 5 percent and snack nuts while they are up less than 1 percent for the past 12, they are actually down in the past three and six. And what we're seeing is a change in merchandising mix, where people may have been doing more mixed nuts and cashews going back to some peanuts to get better price impact out there. And also, one of the things that happens with private label, you know, as you go through price increases, it brings retailers in some respects to a grinding halt, because it becomes so focused on the buy and not the execution of the merchandising promotions, things like that. I was with a customer the other day and we were talking about pricing and they have yet to adjust the retails and as a result of that, they don't know what to do with promotions over the next couple of months. And so what ends up happening is some of those promotions fall by the wayside, unfortunately, so the pricing is yet to really hit. And I think, you know, it's just my guess, okay, when we come together in about three months from now, when we look at the 12, six, and three on snack nuts, you're going to see probably five, six, seven percent higher retails cross the board, and baking nuts will be just as sizable, and that's when we're really going to see it. I think once the retailers get over the sticker shock of both Planters and private label specifically, the volume will continue to grow. But it will stay in the ten percent, eight percent range, I believe, but that's speculation.

Do you think there's any risk going into the Super Bowl period and you see a lot of promotions around that. Your comment about they don't know what to do with promotions, that we might see less meaningful promotional activity -- you know, meaningfully less promotional activity over the next couple of weeks than we did a year ago at this time?

That's my guess, just based upon what I know our customers are doing. I can't speak to every customer, but I know that we're seeing some activity, but it's not the same type of activity you would have expected with this category. The price increases did dampen it. You're going see more -- I guess options -- you're going to see more salty snacks out there. And Super Bowl typically is dominated by salty snacks versus snack nuts, so we're not going to see any improvement in snack nut merchandising around Super Bowl this year, no.

Okay, and last question for you, Mike, the inventory up big in the second quarter and I missed the very beginning of the call, so if you mentioned this, I apologize, but are you being more aggressive about building inventory to be able to price those contracts appropriately this year?

You mean aggressive in terms of the volumes that we're buying or prices that we're paying?

The volumes that you're buying, I can't tell the prices you're paying.

Okay, well, I mentioned early in the call that our inventory is up about 11 percent in pounds, but it's up 50 percent in dollars.

Okay, well, that makes sense, then. I apologize since I didn't hear that.

That's okay.

Thanks a lot.

Okay.

Thank you, your next question comes from Bob Simonson of William Blair. Please proceed.

Good morning. Mike, on the refinancing and also the progress on your new facilities, do you have, given it's been refinanced, an estimate for interest expense this year?

We do, but I can't disclose it yet.

Okay. I assume that the refinancing, whatever one thought it was, makes it a little bit lower. Did it lower your expectations for interest intense this year?

Because of the interest rate?

Yeah.

Oh, yes, definitely. You know, we expected to pay a much higher interest rate.

Okay. And second, can you update us in you've got some numbers in front of you  -- the whole facility isn't going to get done for some number of years -- the pattern and CapEx that you expect for this year, next year, and the one after?

Well, as far as 2005 goes, of course we will be purchasing the Panasonic site and I think there's about $46 million we have to spend there. After that, the first half of fiscal 2005, I'll kind of turning over -- let's see, first half of fiscal 2006, I don't think there's going to be much activity there. I think it's going to really start after that. Junior, would you...

You'll have some -- the beginning of some new construction costs there as well as the premaking of some equipment. The latter half of fiscal '06 you'll see a much more increased CapEx activities that's primarily due to the finishing of the new construction as well as the beginning of the move and the purchase of new equipment to go into the facility. I really anticipate that fiscal '07 forward you'll see our CapEx start dwindling down, but I really think that the latter part of 2005 is when you see the bulk of our CapEx.

Can you quantify that? I mean is it -- you said 46 for one facility, does the total come out more than 50 for this fiscal year?

Well, we do have some more expenditures to make on the original Elgin site during the current fiscal year, so it probably will approach 50.

45 to 50 in '05?

In '05, right.

And then the next year?

And then the next year in the second half is -- you know, as you know, I think we're calling this whole project -- I believe we disclosed a little over $100 million and I would say probably the remaining third -- or maybe one third of the remainder would probably...

I would say perhaps 10 million for the first half of '06 and probably 20 million during the second half of '06, and then it will start tailing down from there as we move the facilities. And just for all participants, we do -- we have disclosed a time line as part of our financing in an AK and if you get on our website you can link up to that and you can get it and you can see it graphically.

Another question, Mike, your sales in the first half in the aggregate are up about seven percent. Do you want to take a stab at the second half rate of change?

Well,I think -- well, here's my stab. I think it will be higher than seven percent, not necessarily because of pounds but certainly because of higher average selling prices. And as you know with these new industrial contracts, which in some cases are up, pecans are probably up 30, 40 percent prices, just a guess. Consumer's going to be up, especially on the private label side, so they should -- they could conceivably be better than ten percent. I'm not going to commit to that, but it just take the logic through, you should see some pretty good increases there.

So more than seven and possibly in the low double-digits?

That's your number.

That's my number, okay. Want to do the same thing for the gross margin?

You know what, the gross margin is too tough to call right now. We really have to see what happens with these markets.

Very good. I appreciate it. Thank you.

And your next question comes from Sean Durkin of Keen Capital. Please proceed.

Good morning, guys. Thank you. Just real quick, I want to ask you what you see to make you think that the growth is slowing in the entire sector? What are you looking at and then also if you could just talk about a couple calls ago the supply demand curve with prices and when are people going to start not buying pecans?

Well, you know, buying pecans, we actually thought that we...

I'm sorry, not specifically pecans, just anything, when the prices are going crazy.

I think, you know, we're going to learn that year, this quarter, I'm not smart enough to give you a definitive answer, but I think as we look at the baking nuts sector, we're going to see retail prices out there on the big three, especially pecans, eclipse 6.50 per pound range on average, and higher than that. And I've never seen prices that high in my nine years here, and I think that's definitely going to slow down large bag volume. I mean we've even seen some large retailers across -- you know, like the Club Channel, Ernie tell members they're going to be limiting their purchase of pecans to one bag per shopping trip, so I think you're going to see a trade down in terms of sizes. I don't think your core pecan users can use less -- you know, frequency that they're going to use less, just based on the price. Walnuts are going to be up a little bit. You might see some transference of pecan use to walnuts, more as an ingredient in recipes versus baking, because they're not interchangeable for baking. And in almond prices we've seen, you know, a meteoric rise in almond prices as well as consumption. I think where the prices are getting on that you're going to see some slowdown, but they've got such a halo effect that people are going to still use then as ingredient and components. I think on snack nuts, peanuts we shouldn't see any decline, we should probably see an increase, since the merchandising mix is probably going to skew there because that's the one stable, if you will, item or nut type. Depending on where prices shake out on private label and Planters, you're going to see cashews and mixed nuts, I think, once that they're established and the consumer gets used to them, we're going to see -- you know, we're going to continue to see good growth there. Almonds, when you look at the past 52 weeks, still growing at 43 percent clip per Nielsen on the grocery channel, you're going to see some pretty dramatic increases there this quarter. I think there will be some slowdown there. Once again on open almonds, it's like the darling of the snack nut category now for growth. All the private label customers in spite of the price increases are forging ahead with new almond items, so we should see some, you know, bump from just new distributions and stuff. And one other concern, not necessarily from a price standpoint, but supply standpoint, could be sunflower seeds and sunflower kernels, because that crop was decimated this year, and there will be some interruption in supply across all customers and sunflower seeds were growing at a nice ten percent clip. So that could become kind of like macadamias, where they won't be there. They will be in the higher price and they could slow down as we come into the -- kind of the selling season across the country, with baseball season and stuff like that.

Okay, and just, real quick, could you talk a little bit about the overall category, the slower growth. What are you looking at that makes you think that -- I mean other than the sales, is there anything you're looking outside of that makes you think the category is slowing down?

There's nothing outside other than just what we're seeing in the category. I think there's still great interest in nuts and nuts are conducive to any health style, lifestyle, diet plan, meal plan, but I think the euphoria that did carry some of the nut growth of Atkins and stuff has waned and I think as, you know, we move into things, and we've had a lot of conversations with retailers since they moved to glycemic control type focus and heart-healthy focus. Nuts fit in there and we've just got to make sure that, you know, as an industry and as a company that we keep nuts as part of the merchandising mix and push the customers to continue to merchandise on a regular basis in spite of the price increases. I think there's nothing worse that a retailer could do than put the prices out there and then shrink away or shy away from merchandising this category, 'cause it's still an impulse purchases category and you need that.

Okay. Thank you.

Thanks, Jim.

Once again, ladies and gentlemen, if you wish to ask a question, please star, followed by one. And your next question is a follow-up from Chuck Sarankowski of Key McDonald. Please proceed.

Jim, can you give us your thoughts on the big ad push that Emerald's expected to -- well, they've been advertising, but I guess they are going to be doing quite a bit on the Super Bowl -- is that a competitive event, or does that help the whole category?

Well, I think that any event like that helps the whole category, and it will also help them. I mean, one of the things that we still see is that it's still an impulse purchase category, and while TV ads are good, and if you look, I just saw some numbers where Planters' spending is up and Diamond is -- or Emerald, Diamond on behalf of their Emerald brand is putting this big push. We still think -- and I think, you know, the retailers will tell you, too, that you need that in-store. But it will have a good effect for the whole category, especially if they talk about health benefits of nuts and driving people into the category.

Thank you.

And your next question comes from Wayne R. Campbell of Black Rock. Please proceed.

Yes, good morning. Just curious to know if you've seen any pickup in the unsalted demand for nuts at the retail level. And if that's true would that have any impact on you folks at the margin level?

Well, first, we're seeing a growth on more light salt products and unsalted, and the light salt is driven by new item development on the private label side. And also, you know you've got that -- you've got a group of consumers that still want the flavor of salt but need to control it for either specific health concerns or just for limiting their intake as part of their overall health plan. So we see that as a growth opportunity for item and SKU distribution and the consumer is responding to that. That does cannibalize some of the base items, obviously. I'll turn it over to Mike to speak about that from a margin standpoint if there's any impact.

No, there's really no impact from a margin standpoint.

But you are seeing growing as a subcategory, if you will?

Sure, and, you know, one of the things we've talked to all of our private label customers about it, one of the challenges -- there's two challenges we face in getting those items out there in private label. First, the long time it takes to develop and execute new private label from concept and approval, to getting it to shelf. And, two, shelf space is a concern. While there's a couple of retailers that have grown their shelf space with the growth of the category, shelf is tight today. And one of the things that we're doing to address that with customers is when we get into these light salt items, offering a different case pack or case count than the base item, to try it fit it into existing space without causing out of stocks and creating further pressure on the key item.

I know the government when they just revised their food triangle there, I think they did come out with some recommendations on the amount of sodium in the daily diet. I think it was lower than the original numbers. Thank you.

Okay. Thank you.

Thank you, at this time you have no further questions. I would now like to turn the conference back to Mr. Valentine for closing remarks.

Again, as always, we thank everyone for their interest in our company and participating in today's call, and we wish everyone a good day. Thank you.

Thank you for participating in today's conference. This concludes the presentation. You may now disconnect. Have a good day.