John B Sanfilippo & Son Inc (JBSS) 2006 Q2 法說會逐字稿

Good day, ladies and gentlemen. And welcome to the Q2 2006 John B. Sanfilippo & Son, Inc. earnings conference call. My name is Candace and I'll 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 today's conference. [OPERATOR INSTRUCTIONS]

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

Thank you. Thank you for participating in our quarterly conference call for the second quarter of fiscal 2006. With us at the Company today are Jeffrey Sanfilippo, Executive Vice President of Sales and Marketing; Jasper Sanfilippo, Jr., Executive Vice President of Operations; and Bobby Tankersley, Senior Vice President of Sales and Procurement.

Today we may make some forward-looking statements. These statements are based on our current expectations and involve certain risks and uncertainties. The factors that could negatively impact results are explained in our various SEC filings that we've made, and we encourage you to refer to these filings to learn more about these risk factors.

Looking at the income statement, quarterly net sales grew by about 4% to $191.1 million from $183 million in the first -- in the second quarter of fiscal 2005. The primary drivers of growth were increases in the food service, industrial, consumer and contract packaging distribution channels that range between 4% and 12%. Sales increases came from higher average selling prices even as unit volumes sold declined in all distribution channels and in all major nut types, except for walnuts. Unit volume sold declined by about 11.6%.

Year-to-date net sales grew again by about 4% to $329.7 million from $317.7 million for the first two quarters of fiscal 2005. This increase can be attributed to growth in the foodservice, industrial, export and contract packaging distribution channels ranging from 2% to 14%. Again, higher average selling prices, even though unit volume sold declined by about 11%, also contributed to the increase in year-to-date net sales.

Second quarter gross profit margin as a percentage of net sales declined to 8.4% from 13.7% a year ago. The decline in gross margin can be attributed to higher tree nut costs and in fact, our tree nut costs were approximately 18% higher than they were in the second quarter of fiscal 2005, and also in declines of unit volumes sold and produced. Cost increases and volume declines had roughly the same impact on our gross margin during the quarter.

The decline in unit volumes sold came primarily from a decline in private-label snack nut units sold as retailers did not have adequate margins to fund promotional activities due to higher tree nut costs. Higher margins on walnuts, mixed nuts and peanuts were offset by lower margins on sales of macadamias, almonds and pecans when compared to sales of those items in the second quarter of fiscal 2005. Because of the late pecan harvest this fall, lower cost new crop pecans did not contribute to profitability to the extent that we initially expected. The late pecan harvest was also a significant contributor to the decline in production volume, as our pecan shelling plant was down for approximately six weeks in the quarter. There was also a substantial decline in the Company's finished goods inventory during the quarter, and this also contributed to the low production volume.

In December, gross margin improved as a result of some of the lower costs on the peanuts, pecans and cashews that I mentioned earlier. Year-to-date gross profit margin declined to 8.9% from 13.2% a year ago, as a percentage of net sales. The decline in gross profit margin came about as a result of, again, higher tree nut costs and a decline in unit volumes sold and produced.

Quarterly selling and administrative expenses as a percentage of net sales increased slightly from 7.7% in the second quarter of '05 to 7.8% in the second quarter of the current year. Quarterly selling expenses specifically decreased 6.0% to 5.8%, due to decreases in distribution costs, which were largely offset to a large extent in increases in compensation and commission costs against the higher sales base. Quarterly administrative expenses increases from 1.8% to 2.0%, again, as a percentage of net sales due to higher retirement costs and compensation costs that were offset in large part by decreases in corporate governance costs.

Year-to-date selling and administrative expenses increased from 8.4% in fiscal 2005 to 8.6% in the current year. Year-to-date selling expenses decreased from 6.5% to 6.4%, due to decreases in distribution costs. Year-to-date administrative expenses increased from 1.9% to 2.2%, due to higher retirement costs and higher corporate governance costs in the first quarter. Quarterly operating income fell by approximately -- fell by approximately $9.6 million due to the gross margin decline. Year-to-date operating income fell by approximately $14 million for the same reason.

Interest expense for the quarter rose by $733,000 and interest expense year-to-date increased by $1.9 million, due to increased short-term debt levels and higher short-term interest rates in comparison to a year ago in the case of the quarterly comparison. That increased long-term debt in the first quarter led to the increase in interest experience in the year-to-date comparison.

Because of the lower gross margin in the second quarter, the Company reported a net loss of $64,000 in comparison to net income of $6.4 million in the second quarter of last year. For the same reasons, current year-to-date operating results fell from net income of $9 million for the first two quarters of fiscal 2005 to a net loss of $1.2 million. Because of lower cashew, pecan and peanut costs that were realized in December, the operating results improved in the second quarter when compared to operating result in the first quarter of the fiscal year.

Primarily as a result of higher short-term debt levels and the net loss reported in the first two quarters of fiscal 2006, the Company is not in compliance with two financial covenants in it's bank credit facility and one financial covenant in it's note agreement as of the end of the second quarter. The Company as received a waiver of it's non-compliance of the two financial covenants under it's bank credit facility, along with an increase in that facility of $20 million that should be funded today. The Company is currently reviewing a draft of an amendment from it's long-term lenders that waives the non-compliance of the one financial covenant under the note agreement, and expects to execute this amendment shortly. The Company beliefs that it will not be in compliance with these covenants under both credit facilities at the end of the third quarter, and will seek waivers from it's long-term lenders for the covenant violations of the note agreement at the end of the third quarter if necessary.

We do have a waver for the bank credit facility, the Company believes that in the third quarter, it will complete a renewal of the bank credit facilities for another three-year term. The existing facility will expire at the end of May. Although waivers of covenant violations are expected and have been obtained in certain cases, since the Company was not in compliance with financial covenant in the note agreement as of the end of the second quarter and expects to be in violation of that same covenant in the future which no waivers have been obtained, the Company is required to reclassify approximately $57.8 million of long-term debt as current maturities on it's balance sheet as of December 29, 2005.

So total inventories declined only slightly in dollar terms, pounds of raw nuts and peanuts declined by approximately 10.6 million pounds or 9.3%, while the dollar value of these goods increased and largely offset the decline in the value of finished goods. The value of finished goods on hand at the end of the second quarter declined by approximately 21%, primarily as a result of lower --- significantly lower quantity.

This week we received notice from the United States Department of Justice that the investigation of the peanut industry has been closed and there has been no impact of that investigation on the Company.

At this time I would like to turn the conference over to Jeffrey Sanfilippo who will comment on some of the distribution channels.

Thank you, Mike. Good morning, everyone. First, let me start out by announcing some good news. As you may have read in a December press release, our Senior Vice President of Consumer Sales resigned at the end of 2005. I'm pleased to announce today that we found a strong replacement from within our Company. We promoted [Ron Williamson] to Vice President of Consumer Sales. Ron's been with our Company for ten years as a business manager for the southern region. He's been instrumental in growing both our private label and Fisher business at Wal-Mart from $1 million to over $100 million today. Ron is well-respected by his associates and we're confident in his abilities to lead what is already a professional consumer sales team to set new goals and continue to grow our Business.

Turning to the results for this quarter, it was a disappointing second quarter for the Company, especially for the Sales and Marketing divisions. Although dollars were ahead 4.4% or over $8 million, every business unit was down in volume measured by pounds shipped. This was lead by declines in the industrial and consumer business channels. The total Company pounds were down 9.8 million or 11.6%. There are several reasons for the volume decreases. We have talked about in the last quarter looking at the consumer channel -- higher prices passed on at retail have caused the category to remain relatively flat to a small decrease. And also due to the higher commodity costs, there have not been the levels of promotional activity that we've done or experienced -- the industry has experienced in the past in the consumer channel.

Looking at the category; in the snack -- for snacks in the past 52 weeks total snack nut sales have increased 2.6% in dollar sales but decreased 0.9% in unit sales. As mentioned since our April report of last year, we can see the category growth slowing down as dollar sales are up only 1.3% and unit sales are down 2.4% for the last 13 weeks. However, this is better than last month when dollar sales were up 0.5% and unit sales were down only 3.3% when looking at 13 weeks ending 10/22/05.

We have seen this trend carry over to pounds. Pounds are down slightly 1% when looking at the last 52 weeks and also they are down 3.6% and 3.2% for the last -- [technical difficulties].

Okay. The last 13 weeks looking at the Fisher brand -- last 13 weeks, ending 12/17/05, Fisher increased 17.5% in dollars and 0.8% in units. In the last 52 [inaudible] Fisher snacks, the average retail price has increased $0.21 as we pass price increases on to -- to our customers.

You are off line.

Am I? [technical difficulties]

[OPERATOR INSTRUCTIONS]

Okay. Sorry, we had technical difficulties. I think we're back on, now.

I was just talking about the snack category in the consumer channel, and for the last 13 weeks ending 12/17/05, Fisher sales increased 17.5% in dollars and 0.8% in units. Looking at private label, it's still showing decreased sales in the consumer channel, down 0.8% in dollars and 4.8% in units in the last 52 weeks. As mentioned in the last couple of quarters, private label is lagging behind the category, private label is down 0.9% in dollars and 5.2% in units for the last 13-week period.

Turning to the baking category, the past 52 weeks, baking nut sales have increased 10.7% in dollar sales, driven mainly by price increases, and only up 0.1% unit sales increase. But pounds are down slightly in the baking channel with 1.3% decrease when looking at 52 weeks. Fisher Chef's Naturals in the baking category has increased in sales in the last 13 weeks, up 58.3% in dollar sales and over 29% in unit sales. Dollar increases are up partially due to the price increase that took effect in early 2005, but also we gained new distribution in the Northeast and also in the lower Midwest, with new retailers that we picked up the category of baking with.

Turning to private label baking, a good success story. Private label is up almost three times out of the category, increasing units, dollars and pounds. Private label baking has increased 28.5% in dollar sales and 9.4% in unit sales. It's actually up over 14% in pounds.

Let me move to the foodservice channel and talk about that for a little bit. Foodservice volume was down 4% in pounds, driven mainly by the increase in commodity costs -- a lot of chefs and users of nuts in the foodservice channel either reduced the formulas to reduce -- mitigate their price increases or just stopped using nuts until they can see lower commodity costs. But we also see opportunities in the foodservice channel with our chain accounts and also through contracts that we have with some of the bigger restaurant chains as they look to try to drive costs out of their system.

At this time, I would like to pass the phone over to Bobby Tankersley who is going to give you an update on the industrial channel.

Thank you, Jeffrey. While revenue for the industrial channel was up 4% for the quarter, unfortunately pounds were down 22%. This was across all of our commodities, primarily driven by the result of extraordinary high prices -- record high prices in almonds and walnuts and pecans-- excuse me -- and the effect they had on our industrial manufacturers. While our pounds were down 22%, approximately 20% of that overall decline was attributed to two individual customers in that quarter, one was an almond customer whose business we did not pick up for the period, and the other was a large pecan customer that has a seasonal product that ships entirely during that period that we did not service this year.

The new product development that we see in pecans and almonds and walnuts and nuts of all types, continues to be strong. However, we are seeing evidence that companies are either delaying roll-out, or are converting to non-nut products. During the period, we had about 50% of the pounds in dollars that were a part of new product development roll-outs during this period as opposed to a year ago. However, we have got about the same amount of product development projects both in pounds and dollars in the pipeline for the rest of the year, so these could recover if commodity prices do eases.

Part of the difficulty that food manufacturers are having with these record prices have forced them to go to private reformulations, they've slowed down the line extensions that they typically launch for new products. And we're just seeing a decrease, overall, in consumption and demand as a result of high prices.

Thank you, Bobby. Just a recap on the sales and marketing. We're optimistic that our sales and marketing strategies in place will help up regain some of the unit volume across all channels. We're also optimistic that we'll be able to look at promotional levels that we saw a couple of years ago, especially in cashews and mixed nuts.

Also, our centralized marketing efforts are beginning to show results as we leverage channel opportunities and develop new items that can be sold across all channels. Our new Director of Corporate Marketing, [Julie Nargain], and her team of strong marketing managers are working on programs with every business channel to help increase our distribution, create new items across all channels and continue to drive volume through -- through our Company.

Some of you may ask about the Supervalu acquisition of Albertson's -- we are, as a Company, very well-positioned with Supervalu, both on private label and Fisher within the different Supervalu regions. And we're optimistic that there are further opportunities to development our business with Supervalu going forward, especially with the acquisition that they've just made. Mike, back to you.

Okay. Thank you, Jeff. At this time, we'd like to thank everyone for their time and interest in JBSS. As Jeff mentioned, we do have reason to be optimistic about our prospects for growth. And we certainly are optimistic about the trends that we are seeing in tree nut markets. And at time, we would gladly take your questions.

Operator, will you please queue up the first question?

[OPERATOR INSTRUCTIONS] Our first question comes from the line of Scott Van Winkle of Canaccord Adams. Please proceed.

Hi, a couple of questions -- actually several. First. let's talk about the inventory. Mike, I think you said that while inventory was relatively flat in dollars year-over-year, it was down 11% in pounds; is that correct?

That's actually about 9%.

Oh, 9%. So if you are down 9% in pounds, let's -- it means roughly we're talking about a 10% higher price per pound in your inventory. If you look at some of your larger nut volumes -- pecans and almonds, where you seem to have negative variances right now, where does your average price per pound on almonds and pecans compare to the current market price for those commodities?

Our current average cost per pound on pecans is probably in line with the market, maybe even slightly -- I'm talking about the purchase market now -- even slightly lower than that, because of the margin-- the cost [inaudible]. In the case of almonds, it's significantly higher than the current market.

Okay. And what does significantly mean? 20%? 30%?

I would say at least that. But one thing I need to add is that it's higher than the selling prices in the industrial market, but they are not higher than the selling prices in all of the other channels.

Okay. That's before a lot of processing goes into those commodities, correct?

No it's -- I'm comparing apples to apples here.

Okay.

I back out all of that processing. They -- so you get a good comparison. The market in the other channels is substantially higher than it is in the industrial channel and does a lot for profitability in those other channels.

If you want to blow out at the moment inventory, you don't really have a chance to throw it into an export market or an industrial market because of your pricing situation? You are going to have to hold it and go through the consumer channel? Is that correct?

Yes. Consumer, foodservice and contract manufacturing.

What about any other nut types? Are there any other nut types where you are in a bad situation relative to current market price?

No. There are no others.

Okay. And what percentage of your inventory is almonds?

In pounds terms or dollars?

Whichever you want to give.

Okay. In pound terms, it's roughly about -- oh, a little over 10%.

Okay. And what percentage of your revenue mix this year would be almonds?

It should be -- probably slightly higher than it was in the prior year, simply because average selling prices are higher.

Okay. Did you do anything this quarter to reduce inventory -- inventory in dollars looks a little better than it did at, least sequentially, relative to your inventory days. And I know this is a period where you are normally making purchases. Did you do anything to unload some inventory into contract manufacturing or anyplace where you would clean off some inventory?

We made a concerted effort to reduce our finished goods inventory, and in fact we slashed it by about roughly 20%.

Is that the reason we see the lower margins? Because you got aggressive with some promotions to get rid of some inventory?

No, actually I think the reduction in the finished goods probably had a negative impact on margin because it resulted in lower production volumes and a lower favorable absorption variance.

Did you idle any of your operations in the quarter?

No, not by choice. I think I mentioned before that our pecan shelling plant was down about 6 weeks. And that was a period of time where it ran in the prior second quarter -- ran that whole time, so -- but that wasn't by choice.

Okay. You mentioned lower sales in the private label side, obviously the data -- the Nielson data would play that out. What happens if Planters takes a price cut -- with commodities coming down? And you already have this narrowed price premium between your private label business business and Planters -- what is going to happen to your margins in private label -- or your volumes, what is the scenario there?

Scott, we don't expect Planters to increase their prices. They never took the price increases last year that most of the other nut manufacturers did. So we don't anticipate them lowering. There's an article in the Chicago Trib last week about Planters -- or Kraft in general, and they made the comment about nut commodity costs being high and driving their margins down. So we don't anticipate them dropping their prices.

Do you see any proactive activity, then, to lower prices in private label to get these volumes back up and increase that value proposition for retailers?

What we see is opportunities to promote -- we really haven't done any promotions in the last two years, per se, on specifically mixed nut and cashews because of the commodities. Now we'll have opportunity with the lower costs to begin promoting again. If you remember, nuts are 80% bought on impulse, so we need to get that promotional activity back to -- to regain the growth in the category.

Okay. Happy to see your replaced the VP of Sales position. But it seemed like Jim did a lot of thing beyond just sales. Is -- have you been able to fill those other roles, things like forecasting? How are you handling -- it would seem to me to be a lot of things he did beyond just the normal head of Sales role.

We've reallocated some of his responsibilities. We've actually -- another promotion that I did mention is we have a promotion for [John Nagey] who has been promoted to Vice President of Supply Chain Management. He is going to be responsible for helping with the forecasting, the customer service levels, the shipments, some of the quality challenges that we have had in the past. A lot of Jim's responsibilities have already been delegated to other personnel.

Moving over to the facility. The $20 million of incremental capacity on your current credit facility, is that a function of forecast loads because of the results? Or is that a function of expecting to be above budget on the Elgin expansion?

No, it has nothing do with the Elgin expansion. We have basically had the same credit facility for six years now. And obviously, we have outgrown that facility. And the only reason why we haven't expanded it sooner was because all of all of the funds that we've raised for the facility consolidation project -- since that was done so far ahead of the project, we just relied on that for working capital needs. But now it's time to allocate those funds for the project and get a line of credit in line with our current size.

Okay. So you mention you are ahead of schedule because of favorable construction weather, I guess. So are you also on budget for the Elgin facility?

Currently we're on budget. And keep in mind, right now we're only in the expansion phase, but so far that particular phase is on budget.

And what is the timing for occupancy again?

We're going to start occupying that building in the latter part of the next summer with our warehouse and distribution activities. This upcoming summer, excuse me.

Just one more and I'll turn over the floor. You mentioned that corporate G&A was up year-over-year and partly due to retirement costs. How -- how would your corporate G&A go up when the person retires and you haven't replaced -- or filled that seat yet? Are you paying him more after he's retired than he was when he was employed?

No. He's -- I would say he's probably going to get -- not much more -- he won't get more than 50% of his salary. That's the maximum he could receive. But keep in mind that that retirement expense is for a whole group of people, not just for him.

Okay. Okay. All right. I'll turn it over to someone else, thanks.

Thank you, Scott.

Our next question comes from the line of Chuck Cerankosky of Key/McDonald. Please proceed.

Good morning, everyone.

Hi, Chuck how are you?

Doing okay. Mike, I was wondering, as you see these various pluses and minuses here -- the volumes over absorption, the trends in the various nut types, pricing, and following what -- what seems to be historically steep decline in your gross margins, if you can give us some perspective on what pace margins -- gross margins will recover? Because that's seems to be the key number here that has been-- at least from my standpoint, hitting new downsides that we just didn't expect.

Well, I think it's safe to say -- and again, thanks to cashews, pecans and peanuts that we will see steady improvement in gross margins over the next 12 months. We'll certainly entering into -- or enjoying substantially lower cashew costs in the latter part of the summer. And we have bought those cashews already. Pecans are -- of course we bought those in the fall, and they are down -- what was it Jeff, about 25%? 30%? So we'll start to see some benefits from that right away, in fact we saw those in the latter part of December.

Well -- and how about in the overall pricing environment? Because that's -- that's the other side of the coin. And the actual volumes? Where does that have you coming out on the gross margin, Mike?

Well I think -- we will continue to have-- experience volume declines, although it will slow as each -- as we move through each quarter. And of course the major promotional activity that Jeff spoke about really won't kick in until -- at least in any significant way, until we get into the busy season starting in the latter part of next summer. That's really when you see the benefits of promotional activity.

Does that -- does that suggest that there's -- because of the volume issues, does that suggest that there's limited upside in gross margin over the next two or three quarters?

Well, I think there's -- there's certainly going to be improvement in gross margins, just based on the cost of structure that -- that we're seeing right now. But certainly it would be limited. But it will improve as each month goes by.

Do you think you could get back to a double-digit gross margin in the second half of the year, taken as a whole?

I -- difficult to say right now, Chuck. Volume is going to be a major part of that. And we have quite a few opportunities out there to pick up new business, some of it is getting near completion. And we'll need that to get to where -- to get to double-digits.

All right. Thank you.

Okay, Chuck, thank you.

Our next question comes from the line of [Jeff Bershel] of [Poler]. Please proceed.

The interest expense -- and I know you capitalized some interest in the quarter, but just taking a look at the debt balances -- and I know it swings around because of working capital, et cetera. Just wondering, where you think interest rate -- your interest expense would shake out aside from any -- charges for the waver?

Well, we expect to have debt balances that are going to be pretty consistent with last year. And I think we're looking at, what, about 200 basis points or so on the short-term rate? Yes, maybe a little bit more than that -- so I think that's how it should play out.

I understand there is a ramp-up phase in the new facility, when -- but at a run rate level, what do you think the fixed cost absorption impact is going to be on an apples-to-apples basis with what you are winding down and what you are starting up?

I'm not sure -- ask that question a different way -- I'm not sure I understand the question.

I guess when you guys -- this summer you'll be in the new facility?

Yes.

I was just wondering what the impact of the P&L will be in the calendar Q3, Q4 timeframe -- whether it's going to be a positive impact or a negative impact?

There won't be much of an impact in calendar '06 because we're only moving our distribution operation in there.

You'll have to -- obviously, you're capitalizing stuff now, so you'll have to carry a hire fixed-cost absorption. So I'm just trying to see if that shakes out anywhere in the -- ?

Yes, but it's going ramp-up as we -- place things in service. So there should be a corresponding absorption as the fixed costs increase.

Okay. And I may have missed this on the call earlier, but I'm just trying to get a sense of how much CapEx was forecasted to finish the facility. Just an update from what you talked about last quarter on the call?

Our totaling budget for the facility consolidation project is about $96 million. And I -- I don't -- I think we've already spent about $65 million, so far.

Okay. And you're extending the credit line by $20 million, it looks like -- or hoping to?

That should be funded today.

Okay. So I guess -- is the -- looks like there was about a $30 million gap there. Are you forecasting that you will be cash flow positive to generate the incremental amount, o r-- ?

Also keep in mind that we will be selling quite a bit of real estate here in the next month or so. And that real estate will generate -- in this fiscal year, should generate about $20 million in proceeds. And then also reduce long-term debt by about $6 million. And then we have to start marketing the original Elgin site, which we expect to have the deed on that here pretty shortly, and sell that off sometime in the this calendar year.

What is the rough market value of that? I know you're probably going to sell this, so you don't want to tell people. But, what's the book value?

We haven't disclosed it, so.

Okay. Square footage?

Square footage of the new facility?

Yes. No sorry,of the Elgin facility you are selling.

No there's no building on that -- it's vacant property. It's about 85 acres.

Okay. And just going over the profile of the Company over a long time frame, look at the stock price, the margin levels, and try to understand what is going on, --can you guys actually pin when you could foresee being profitable again?

Well, I think-- I think there's good reason to believe we'll be profitable in the third quarter.

Okay. Because it looks like over a long period of time, that the quarter is normally been one of the weaker quarters from an earnings perspective. So given you just have had a string of two loss quarters, I'm try just trying to figure out where the profitability shake-out.

When we're talking about cashews, peanuts and pecans, we're talking and roughly, at least 60% of our sales. So with those costs down significantly and going down, really almost by the week, it gives us reason to be optimistic in the third quarter.

Okay. And then the almond -- I guess the discussion on the conference call earlier about almonds is you -- did you hedge or did you supply forward? Is that why you're locked into higher costs in the current market?

Right. We bought forward.

Okay. All right. Thank you very much.

Okay. Thank you.

Our next question comes from the line of [Larry Bernstein] of [Amber Mountains]. Please proceed.

Thanks for taking the call.

Okay, Larry.

Gross margins in years 2003, 2004, and 2005 were 17.4%, 17.6% and 13.5%, respectively. And gross margins have only been 8.6% in the first six months. Where do you think those margins to be in the final six months of the year? And where do you expect those margins to be in the years ahead?

Okay. We -- we don't give guidance, Larry. And I I apologize, but we can't answer that question.

That's fine. What about a more general question; in the long run, where do you see steady-stay gross margins then?

Steady what?

In the long run, do you expect it to return to a 12% to 14%?

Well I think -- we define-- if you look at our market price graph on our website, you'll see that, and call it between 2000 and 2004, we would define declining markets as normal in those years. And in those years we had, roughly, about a 17% gross margin. So it stands to reason that, in normal commodity markets, our normal gross margin should be around that level.

Thanks.

Okay.

Thank you very much.

Okay. Thank you.

Our next question comes from the line of Scott Van Winkle of Canaccord Adams. Please proceed.

Hi, guys. Couple of follow-ups. What changes have you made to how or who buys almonds, going forward?

Well, why don't you -- ? Bobby Tankersley is actually buying almonds, going forward. Bobby, do you want to tell us what your approach is? Going in the hot seat.

I'm not sure what we want to reveal what our approach is, because the growers and folks that we'll be dealing with. But we'll probably make a few changes in the way that we approach the market in the coming years. And we do buy nuts directly from growers, we have a processing plant so we need grower nuts in order to be able to operate that facility profitably. And we'll continue to do that. And we'll probably continue to hedge that by buying product from processors, as well, to fill in gaps of individual items that we might need to balance up on. So we'll-- we'll put together a comprehensive buying approach, going forward, that hopefully is going to be working for us.

There's no way of -- of limiting your downside, or even your upside for that matter, on the commodities? Is there any large-- processor or purchasing company out there of raw almonds that you can maybe outsource the operation to? This is the one nut -- it's been like a two-year pain, is the way I'm thinking.

Right. Well let's go back to the decision-making process this summer. As we -- as we had promised about a year ago, we're going to make an effort to fix our almond cost. We get into the latter part of the summer and see that we're in the midst of, what I would describe as a stratospheric increases in almond demand, and a crop that looked like it was going to be about 15% short, now it turns out it's about 10% short. We made a conscious decision to get covered on almonds and get covered at a fixed price. Many of the people in the almond industry made that same decisions, whether they were handlers or manufacturers or even traders, for that matter. So -- and basically, after coming off of about two or three years of rising almond prices, it seemed to make sense at the time. Obviously, in hindsight that did not work out. But I think we're still committed to buying our almonds at known and certain costs to a much larger extent than we have in the past. And we'll continue to take that approach.

It is also my understanding that, not necessarily this -- this harvest but the following harvest, we'll see what conceivably could be a 20% increase over a normal almond crop, as new acreage comes on. And that will continue to increase over the next five years. So we're certainly going to take a very guarded approach to our almond position, given that we do expect to see larger crops in the future. But again, I want to stress that we are committed to fixing our almond acquisition cost as much as we possibly can.

Okay. And you are talking about going into Q3 and easing commodities being favorable for you. But you have got 100 days of inventory currently, right now on your balance sheet. So can we see an impact in the next quarter from a decline in the current market environment for commodities? Isn't it two plus quarters away?

Well, I think -- if you look at it in total, you might see 100 days there. But that isn't necessarily the case for every nut. And with respect to the nuts that are declining and specifically, I'm talking and peanuts and cashews, it's not even close to 100 days. So we're in a good position to take advantage of that declining market on those items.

Okay. The other question is, you -- I don't mean this to be beating you up, but you have a stock that's falling a lot, so you have got some incentive compensation for -- for your employees. You have lost a key member of your management, you are making a facility change -- how do you limit any potential turn over? Usually when you see a department head leave, particularly in times of poor operating performance, it usually means there's more to come. What have you done to solidify things?

From the sales standpoint, Scott -- five of the seven business managers that were direct reports for Jim were hired by me within the last five to ten years. And I'm confident that these gentlemen are committed to the Company, have spoken with each of them individually. Obviously, there's always the risk of -- of some transition, or loss of other employees, but we have a great sales team here across all business channels. And obviously, the transition is not going to be an easy one, but I'm confident with Ron's abilities, once he comes up to Chicago, to lead the Consumer Sales division. And I'm confident that we're going to continue to grow our consumer channel.

I would also add, Scott, that at least with respect to the Sales and Marketing team -- the departure of the high-level executive, at least from that point of view, is an opportunity for them. And that's how they are seeing it.

I think that's fair. And then on the other side, you are a public company so your results are out there. You have a facility -- a major facility conversion going. And again, you have lost a senior salesperson -- how do you make your customers feel good about what is going on? Because some of them are pulling up your results and they know there's some change happening, and maybe they are afraid that their inventory will be a little late getting to their warehouse in a year and a half when you're moving into the new facility. Have you gone out and touched them and shown them some love?

That's a good way to put it, Scott. Obviously, we're committed to our customers.We're going to make sure that they know that we're committed with them. We're going to have more top-to-top meetings with the major customers around the country. Our business managers have great relationships with those customers. And we're going to make sure that they know of the changes we have made in some of the different departments, improving our marketing, improving our sales forecasting, working with them to closer, going forward. So yes, there's some damage control obviously, whenever anyone from senior management leaves. But I'm confident in the Company we are and in the Company we're going to continue to be to take care of our customers.

Scott, this is Mike. I would also add too that not withstanding this volume decline, we're still -- especially I in the first and second quarters, operating at capacity. We need to do this to better service our customers. In fact, under the current conditions, an argument could be made that it's -- has an negative impact on our ability to do that. And we have gone to our customers and told them that, without a significant amount of excess capacity to deal with the busy seasons, this problem will continue. So I think they are actually looking forward to it.

Are -- are you shorting any customers now?

No.

No. Scott, I want to put you in a room with my current sales and marketing department and see if you can pick holes at them, because they are very tough.

All right. Guys, good luck.

Thank you.

Our next question comes from the line of Chuck Cerankosky of Key/McDonald. Please proceed.

Kind of a big picture question, guys, in our world here of positioning mainly in private label, you have got -- the old Planters brand, the stronger New Diamond brand out there -- are you seeing the room, historically, or do you expect it to return, where you have this pricing umbrella? I have seen in a couple of other categories where the branded leaders -- or new activity buy brands has put some pricing pressure on the entire private label component of the category. Right now, off the top of my head, I'm thinking about the pasta category. And I'm wondering, if longer-term you are seeing that -- you are facing that kind of pressure in nuts?

Well as I mentioned earlier, looking at the categories -- obviously, Planters is the number one brand. They did not take the price increases that most of the industry took. I think part of it was a strategy to grow their market share, knowing that as they decreased the level of retail between private label and the major brand that they are going to gain market share. So I don't anticipate -- obviously, a price war is always a possibility, but I don't anticipate that, even though the markets are coming off. Again, they never took the price increases that most of the industry did.

And Chuck, this is Mike, again, I would also add that -- I think our category is a little different from pasta. Our category moves on promotion. Obviously, pasta is more of a staple, where everyday low pricing can continue to move the -- move the category, that would not be the case in nuts.

Well, with -- with Planters, though, doing what they did to grow market share, can they just continue it? It's not so much that they need to have an every day low price, but if they keep the spread narrow enough versus private label, could it be a long-term market share bleed in their direction from private label to branded?

Yes. And obviously, as Michael mentioned, a lot of it is driven on promotion. And Kraft is a great company, they have done a great job with growing Planters, they have done a great job developing new items -- they are launching a whole new product line of premium nuts in the category, and that's going to help, not only their growth, but it's going drive the category growth as well, which is necessary. You need a brand leader to help drive the category growth. And they've really done a good job taking that position. I think with the commodities coming off, they'll have more opportunities to promote in the future. The private label piece -- retailers are committed to their private label programs. They have equity, it separates them from the rest of the retailers in the industry, and we're looking forward to working with them to grow their private label programs and be innovative in the category.

All right. Thank you, that helps.

Okay. Thanks, Chuck.

[OPERATOR INSTRUCTIONS] Our next question comes from the line of [Steven Chen] of [AmTrust]. Please proceed.

Hi. You mentioned that you were out of compliance in three areas. Why specifically will you not be in compliance in the third quarter if you expect to be profitable?

Because the specific covenants that we're talking is debt-to-EBITDA ratio, which is based on a rolling four quarter -- it's a four-quarter calculation. So obviously, we are carrying some baggage here that will impact the third quarter.

Okay. And can you -- you gave the almond portion of your inventory in pounds. Can you give it in dollars?

Almonds represent roughly -- about 25% of our total dollars.

Okay. And then, with -- in terms of your strategy with the almond inventory -- can you take a write-off? Or if not, how long will it take to work them through the P&O?

Shouldn't take more than 12 months.

12 months. Okay. And then can you just expand upon your strategy with -- going back to private label. With -- upcoming bid processes and renewals, how will you manage this process? Particularly, if you have competitors that could steal your business?

Well, obviously, the gap between the brands and private label is tightening. Then you're going to see some loss in private label. But at the same time, you're going to -- there's innovation in the private label category. So everyone talks about the -- the growth of private label as been fairly flat, again, a lot of that is due to the lack of promotional activity that we've been able to pursue in the past. But I expect that, just as the brands are going to increase their promotional activity with prices coming down, private label will do the same thing. And we'll make sure we lead that.

Okay. And do you have the ability to, and will you, go after some lower-margin business that you may have turned away in the past?

We have got some opportunities to increase our volume on some of the lower-margin business that we lost in the last year. And we're optimistic we'll regain some of that distribution and get the volumes through the plants again.

Okay. Thank you.

Thank you.

Our next question comes from the line of Steve Ranieri of Franklin Advisory Service. Please proceed.

I was wondering if you would go over what operating cash flow was in the quarter? And what your thoughts are on for the next few quarters? And also, capital expenditures?

Operating cash flow was much improved in the quarter over the second quarter of fiscal 2005. I cannot disclose what it was, but we will be filing our Q on Tuesday and you'll see it there.

Okay. Going forward, what is your outlook for what working capital can do over the next few quarters?

I think our working capital needs might actually diminish simply because peanuts and cashews -- keep in mind we have already bought pecans -- but we will be continuing to buy peanuts and cashews over the next 12 months. And it seems like almost every week or certainly every couple of weeks, the cost of that is going down, so should be a great benefit to our working capital situation.

And what percent of your dollar inventory is peanuts and cashews at this point?

It's -- it's almost insignificant. Certainly less than 10% combined.

So how can you really reduce the working capital if it's already a small part of the -- ?

Well, because we're -- I'm comparing in -- in comparison to last year's needs.

Okay.

Right.

What was it last year?

Oh, I don't know.

So do you think it's much lower than it was last year? Is that what you're saying?

Yes.

You have a target on debt reduction? And also, I would like to know how your capital expenditures will roll-out over the next few quarters.

We, obviously, have a short-term target to reduce debt and you can see -- we have been working on that, just by slashing our finished goods inventory. As far as long-term -- when we're talking about working capital, that really is more of a function of crop size and crop cost than anything else.

Okay. You guys are -- you guys are in the market continually purchasing raw material, so can you give any sense at all about what we could expect to see?

It's way too soon to make -- take a guess at that.

Okay. And how do you think capital expenditures are going to roll-out over the next few quarters? What can we expect?

I think, as we mentioned before, we have another $30 million to spend on the facility consolidation project. Most of that will be spent in calendar '06.

Calendar '06?

Correct.

Okay.

And then it will be ramp down. And then the rest is relatively insignificant.

And over the next two quarters for that facility?

We haven't disclosed that.

You -- you have ongoing maintenance expenditures at your existing facility, so what would that be over the next couple of quarters?

We -- we have been kind of tracking at around -- probably about $9 million a year in the last couple of years. And you should probably just use historical on that.

Okay. Thanks a lot, guys.

Okay. Thank you.

Our next question comes from the line of Scott Van Winkle of Canaccord Adams. Please proceed.

Mike, just a quick follow-up here -- I don't mean to keep beating the almond bush, so to speak. Don't you value your inventory at the lower cost of market? And if so, why wouldn't you just go ahead and take a $20 million hit right now in the almonds and get them down to current market value?

Because the current level of almonds that we have in stock and the type of almonds we have in stock are no more than the amount of almonds we ship into the foodservice, consumer, and contract manufacturing channels. Currently, the selling prices in those channels are above cost.

Okay. So you look at retail prices -- or your wholesale prices versus the commodity price?

That's right. Well we look at the prices in the outlets that -- that we will sell them in.

Got you. Thank you.

Okay.

Ladies and gentlemen, this concludes the question-and-answer portion of today's conference. I will turn it back to management for any closing remarks.

Again, we would like to thank everyone for their interest in JBSS and also listening in on our conference call. And this concludes the call. Thank you.

Thank you for your participation in today's conference. This does conclude the presentation. [OPERATOR INSTRUCTIONS] Have a great day.