John B Sanfilippo & Son Inc (JBSS) 2007 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the second-quarter 2007 John B. Sanfilippo & Son earnings conference call. My name is Towanda and I will be your coordinator for today. At this time, all participants are in a listen-only mode. We will facilitate a question-and-answer session towards the end of this conference. (OPERATOR INSTRUCTIONS).

I would now like to turn the call over to Mr. Mike Valentine, CFO. Please proceed, sir.

Thank you, everyone, for participating in our quarterly conference call for the second quarter of fiscal 2007. From the Company today, joining us will be Jeffrey Sanfilippo, Chief Executive Officer; Jasper Sanfilippo, Junior Executive Vice President of Operations; Bobby Tankersley, Senior Vice President of Industrial Sales and Marketing.

Before we get started, we may make some forward-looking statements today. 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 have made, and we encourage you to refer to these filings to learn more about these risk factors.

Starting with the income statement, the current-quarter net sales declined to $177.7 million from $191.1 million in the second quarter of fiscal 2006. A 7.3% decline in the overall weighted-average selling price per pound in comparison to the price per pound in last year's second quarter primarily led to the decline in net sales.

Considerable decline in selling prices in the industrial channel and the reaction to lower market prices for most new crop tree nuts was the primary cause of the decline in the weighted-average selling price per pound.

With the exception of walnuts, lower consumption over the last 12 months and larger crop sizes in some cases led to new-crop market price declines in almonds, cashews, pecans, macadamia nuts and peanuts. Typically, selling prices in the industrial channel closely follow market price changes.

Pounds of products shipped to customers increased slightly over last year's second quarter. Pounds sold increased for pecans, peanuts and macadamia nuts and decreased for almonds, walnuts and cashews. Net sales increased in the export and contract manufacturing distribution channels, while net sales decreased, to a larger extent, in the industrial, consumer and foodservice channels. In the context of pounds shipped, distribution channel mix shifted from consumer to industrial in the quarterly comparison.

Year-to-date net sales fell from $329.7 million to $311.4 million for the same period in fiscal 2006. Again, lower average selling prices were the primary driver in the decline, while unit volume sold increased by 1.7% over unit volume sold in the same period last year.

Second-quarter gross profit margin as a percentage of net sales increased to 10.8% from 8.4% in last year's second quarter. Gross margin increased in the consumer, industrial and contract manufacturing channels and remained unchanged in the foodservice and export channels.

Lower acquisition costs led to increases in gross margins for sales of macadamia nuts, almonds, pecans, cashews and peanuts. Gross margins for sales of walnuts declined in the quarterly comparison as we shipped higher-cost new-crop walnuts against lower-priced old-crop walnut sales contracts in the second quarter.

Year-to-date gross profit margin as a percentage of net sales declined to 8.0% from 8.9% for last year's second quarter. High-cost old-crop inventories, especially almonds, had a negative impact on gross profit margin in October and November. Margins improved significantly for the sales of most commodities in December, when the majority of our raw nut inventories were comprised of lower-cost new-crop nuts.

Quarterly selling and administrative expenses as a percentage of net sales increased from 7.8% for the second quarter of 2006 to 8.6% for the current second quarter. Quarterly selling expenses increased from 5.8% to 6.0%, due in large part to an increase in warehousing and distribution costs at our new Elgin facility. This increase was partially offset by a decrease in shipping costs. Shipping costs decreased because of a decline in fuel surcharges.

Quarterly administrative expenses increased from 2.0% to 2.3% as a percentage of net sales, primarily because of higher audit and legal costs that resulted from the restatement of last year's Annual Report. Additionally, the increase in operating expenses, again as a percentage of net sales, arose as a result of a lower sales base, while certain expenses remained relatively fixed.

After considering the gains related to the sales of properties in the first quarter, year-to-date selling and administrative expenses as a percentage of net sales remained relatively unchanged at about 8.7%. Quarterly operating income increased by $2.5 million to $3.8 million as a result of the improvement in gross profit margin. There was an operating loss of $2.1 million in the current year-to-date period, compared to an operating income of $1.2 million for the first two quarters of last year.

Because of higher short-term debt levels and higher interest rates, interest expense increased to $1.8 million from $1.1 million for last year's second quarter, or as of the end of last year's second quarter. Short-term debt increased in the quarterly comparison primarily because of significant capital expenditures related to the facility consolidation project that were made over the last 12 months. For mainly the same reasons, interest expense increased by $800,000 in the year-to-date comparison. The improvement in gross profit in the second quarter led to net income of $1.2 million compared to a net loss of $64,000 in the second-quarter comparison.

Looking at the balance sheet, inventories at the end of the second quarter declined by $43.7 million or 21% compared to inventories on hand at the end of the second quarter of fiscal 2006. Pounds of raw nuts on hand declined by 17.5 million pounds or 17% in the quarterly comparison. As a result of significantly lower field prices for most new-crop tree nuts, the weighted-average cost per pound of raw nuts on hand at the end of the current second quarter was 20% lower than the cost per pound of raw nuts on hand at the end of last year's second quarter.

Though we were in compliance with all covenants in our loan agreements in the second quarter, we have continued to classify the amount due in the note agreement as current maturities due, due to the uncertainty that exists as to whether we will comply with the EBITDA covenant and possibly other covenants in that agreement in the next two quarters.

Now I will turn the call over to Jeffrey Sanfilippo, who will comment on distribution channel performance, category issues and other matters.

Good morning, everyone. I will update you on the results of our sales and marketing efforts in the quarter, I'll review topline snacking and baking nut category trends, and then also follow up on the remediation plans that we implemented in December to address our going-concern status and material weaknesses.

First, I would like to say the management team is pleased with the Company's results in the second quarter. Profit margins on almond sales in December improved significantly in comparison to gross profit margins on almond sales made earlier in the second quarter, when the Company was still cycling through negative margin contracts.

We should see walnut gross margins improve on sales of higher-priced new-crop walnuts. In addition, the Company is initiating price increases on other nut types such as black walnuts and pine nuts as a result of higher procurement costs this crop year.

I will caution, though, potential margin gains of other nuts may be mitigated by lower-margin pecan sales anticipated this year due to higher average field prices paid for pecans, and this was a result of a smaller crop this year and competitive activity in the industry.

Turning to our sales by distribution channel, results for the second quarter in our export and contract manufacturing channels were strong. Net sales and unit volume increased in our contract manufacturing channel, driven, really, by new customers and new products developed in the channel.

In our export channel, a shift in sales from walnut and almond byproducts to higher-priced pecans and retail products drove net sales increases, while unit volume dropped slightly.

In the consumer channel, net sales and unit volume were down, mainly due to declines in our private label business segment. There are really three reasons for this. First, we continue to cycle against lost sales from a major retailer. Second, we were still shipping private label non-nut baking and candy products in the second quarter of fiscal 2006, which are categories, if you remember, we exited in the third quarter of 2006. Then third, aggressive promotional activity by the national brand at key accounts attributed to some of the declines in our private label business.

The private label sales were offset in part by a 15% increase in Fisher snack and baking nut sales. The solid Fisher growth was achieved by gaining new distribution and increasing promotional activity in both the snack and baking categories.

Let's turn to the trends and dynamics of the snack and baking categories during the quarter and their impacts on our consumer channel. Beginning with snack, snack category for the last 52 weeks has been stable, showing increases of 3.5% in dollars, but relatively flat in unit volume. For the last 52 weeks versus a year ago, the Fisher brand is solid, up 2.3% in dollars and 2.5% in units.

When reviewing specific commodities, I would like to comment that there is still an explosion in almond consumption in the snack category. Almonds have increased 20.7% in dollars and 11.9% in units over the last 52 weeks versus a year ago.

Looking closer, even over the last 13 weeks, almonds are still increasing double digits. In addition, snack mixes that include nuts are also helping drive the category. With a 22% increase in dollar sales over the past 52 weeks and 10% over the over the last 13 weeks, this category continues to show signs of growth.

To complement the growth in these two categories, almonds and snack mixes, we are happy with the result of our new product efforts. Our new product percent to total business is growing with the launch of our Fisher Fusions snack mix line, as well as the launch of our almond and pecan Bold Flavor products. Also, our holiday programs were successful, gaining national distribution in both traditional and nontraditional channels.

Moving to the baking category, the baking category for the last 52 weeks has also been stable, boasting increases of 4.2% in dollars, but relatively flat in unit volume. An increase in the average retail selling price of $0.18 in the last 52 weeks versus a year ago is a contributor to the increase in the category dollar sales.

Fisher brand has posted impressive results over their last 52 weeks in baking, up 38.2% in dollars and 34.8% in units. In addition to the Fisher brand, retail own brand is also strong in baking, up almost twice that of the category, increasing 7.8% in dollars and 0.4% in units.

When we look at nut types in the baking category, pecans are relatively soft, boasting decreases, actually, in dollars and units versus a year ago. Pine nuts continue their steady growth, with dollar sales increasing 10.9% and units up over 9% the last 52 weeks.

Although our overall consumer channel is down in the past two quarters, we're confident the sales and marketing programs we have in place, as well as the project our research and development team have initiated with customer-specific programs, will improve the sales performance in this important business channel.

I would like to now take some time to address the remediation plans we implemented in the quarter to address our going-concern status and material weaknesses. First, the Company has completed the cleaning of all our field run almonds that it purchased directly from growers and will now begin the process of shutting down our almond-handling operation in our Gustinee facility over the next couple weeks. We should -- or will begin to see the cost benefits of this decision with the reduction in overhead in Gustine in March.

Second, the Company enhanced the technical resources in our accounting department to assist with the monthly cutoffs and expedite the financial statement closing process. Also, the Company realigned marketing and promotional strategies to improve sales support and reduce our marketing expenses. In addition, sales and marketing conducted a profitability review by customer and have initiated price changes where necessary. Next step for the third quarter is to review sales and margins by SKU and make appropriate changes to improve profitability by product line.

We had a successful quarter for the Company, but we still have a great deal of work to do. We will remain focused on bringing the best possible service and products to our customers. We will ensure that our sales and marketing and operations teams have everything they need to maintain and grow our customer relationships and business. We will remain focused on moving into our new corporate headquarters in Elgin. Management will continue to make necessary changes and enhance our business practices to improve our performance going forward.

At this time, I would like to pass the presentation backed over to Mike for closing comments and to open the floor for questions.

Before we make our closing comments, we would gladly take your questions now. Operator, would you please queue up the first question?

(OPERATOR INSTRUCTIONS). Scott Van Winkle, Canaccord Adams.

Congrats on the return to profitability. A few questions. First, on the gross margin, the gross margin improvement is obviously from lower procurement costs. How much negative -- and if you touched on this, I apologize -- how much negative pressure was there from the mix shift that occurred?

Well, as you know, there's quite a sizable difference between gross margins in the industrial channel and the consumer channel. Just as a general rule, the consumer channel is at least 500 basis points of gross margin higher than the industrial channel. We saw a shift of roughly about 300 basis points in respect to pounds shipped from consumer to industrial in the quarter.

You talked about some of your plans. Obviously, you are focused on the consumer channel. What is the plan? I heard Jeff mention looking at all the SKUs one by one, but are you just going to wait? I realize you're going to anniversary some category -- some customer losses, pardon me, and that will make that mix shift a little bit better. But what is the plan to get out there and get a little more aggressive now that you have got some lower nut costs?

It's a combination of things. On the Fisher side, it's to increase our promotional activity. If you look at the brands' promotional activity, and private label, we are not keeping up with the promotional activity from our competitors. So that's one area we will increase to grow our business on the Fisher side. New product launches -- we are working on a couple new things for the end of fiscal '07 and going into fiscal '08.

On the private brand side, we are working with a couple major customers now to develop additional items for their programs, as well as heavily pursuing new customers in the private brand business.

And the customers that have been lost recently or the last, say, the last 12 months, was it because of your lack of aggressiveness on the promotional side, or what has been that driver in hindsight now? And are the items you just talked about addressing those specific issues that customers have?

Well, I wouldn't say it was specifically just not driving volume for a specific customer. It was a combination -- our competitor had a value proposition that they felt was better than what we were offering the retailer. They may have felt that we weren't driving their category as much as we could have. I really don't know exactly the reasons for that. I do know that we're still negotiating with that customer and other customers for different product lines for their private brand program.

How about on the Fisher side? Has there been any changes in your accounts on the Fisher side?

On the Fisher side, no. There's some in-shell peanut business that we lost on the Fisher side at a retailer, but other than that, we're actually gaining distribution on Fisher, both in baking and snacks.

On the other channels, particularly the channels where you have a little bit better margin -- let's forget export and contract manufacturing -- in industrial, has there been any changes in the customer mix there? What do you have going not only to drive -- obviously, nut prices had a lot of customers backing off from using nuts over the last couple of years. What are you doing to drive maybe both your own business in industrial, and any improvements in the category, now that we have lower nut costs? Do you have to go out there and kind of notify the customers that, hey, prices are getting better; let's talk about putting nuts back into your baked items and into your product development?

This is Bobby Tankersley. I'll speak to that, if you'd like. In the industrial channel, we focus on our attention primarily on the major food manufacturers through product development in the R&D group. There's been a decline in the number of new products that have been launched and even considered for research and development over the last couple of years because of nut prices. There's a lag time between the time that they develop a concept for a new product, and then it goes through project development and then test market and then the actual launch.

So we're kind of in the midst of that lag time. We had seen a decline primarily because of previous high prices this year. At this point this year, we've got about one-third the number of new products that have been launched through new R&D projects versus this same time last year, and even with projects that are in development, also about a third. So the numbers of new items that are being considered have not reached the previous levels because of the former high-priced nuts.

The good news is that the projects that are under consideration and are being launched tend to be larger projects. So the dollar volume effect and the volume effect is actually going to be offset. What that means is that the larger companies are beginning to re-enter and re-look at nuts for new projects and new line extensions. The smaller companies are a little slower to come back around, and this is in large part because of the former high prices. I think we're going to see a change in that as the new lower-level nut costs cycle their way back into the R&D programs.

How long it was it -- when we saw inflation in nut prices, how long did it take before it actually impacted those customers in their product development, just to get an idea of maybe how long we will have to see lowering prices before we see the opposite effects?

When companies have new products in development, they will typically stick with them if they see high-priced commodities as a short-term phenomenon, and they will follow them through. So we saw products reach market even during that extremely high-priced period because of that commitment.

I would say you've got, on average, about an 18-month lag time before you begin to see the cycle reverse. We saw new products come out during at least 12 months of that high-priced period. So you are probably still 12 months out before you really get the big benefit out of actually coming to market and products actually being shipped.

Perfect. A couple other questions. I asked the question about how much gross margin deterioration there was from channel shift. When you talked about your lower ASPs, those lower average selling prices year over year, could you quantify what percentage of the lower average selling price is also driven by the channel shift?

No, I can't. But maybe you can do the math here. We saw -- I think it was roughly about a 10% decline in selling prices in the industrial channel, and we saw a shift of roughly about 300 basis points in pounds from consumer to industrial.

When is the date now for the headquarters move to the new facility?

Headquarters will be moving the week of February 23. The offices will. We have already moved; we've got approximately 180 employees that are currently working out of the new facility. Our corporate offices will move in the next couple weeks, and then we will continue to break down lines in our current facilities in Chicago and then move them out to Elgin over the next months. We will be finished -- we will be moving out of the major facility in Elk Grove Village by December of this year.

On the last several calls, I have been asking about if there's been any change in the turnover rate of the employees. My concern has been that it would be the new geography that would have an impact on turnover. Has that changed at all? Are you getting closer to the date where somebody is going to have a much longer drive?

The type of turnover that we have been experiencing as we have moved employees and production lines out to Elgin have typically been the more -- less technical positions, people that just hand-pack products off the line or case-pack onto pallets. Most of the technical operators and production supervisors that we have moved out there, we have retained.

I do continue or I do expect to continue to see the lower-educated -- not educated, but lower technical-requiring workforce that live in the city to drop out as we move production lines. But the city that we moved the plant into has a very high workforce that is compatible with the type of work that we will ask them to do. We have had no problems replacing those employees when they have left us.

Anything on the executive side?

On the admin side, we have no notable turnover issues as we get ready to move.

Last question -- are any of your gross margins by nut type reported in the second quarter -- are any of those gross margins back at historical levels yet?

Cashews are back at historical levels. Mixed nuts are on their way to that level; they haven't quite gotten there yet. Pecans in the second quarter exceeded historical levels. But again, as Jeff warned, increasing field costs in recent weeks will bring that back down to probably something around historical levels or slightly below that. Macadamias are far in excess of historical levels. Almonds in the second -- or at least in December did reach historical gross margin levels. Then, of course, walnuts, we saw a deterioration from historical levels.

When you mentioned almonds, you mentioned December specifically. The other nut types -- were you talking December only or the whole quarter?

The whole quarter.

Steve Raineri, Franklin Advisory Services.

I was wondering if you could just tell me the trend in the gross margins in the quarter through December, just to sort of give me an idea of how many basis points difference that would be.

Well, probably starting in October, overall we probably had a gross margin of somewhere in the neighborhood of about 6%. Then in November, it probably crept up about 200 or 300 basis points. Then in December, it improved to over the 11% that we reported at the end, probably in the midteens.

At this point, given I think you said most categories are at or above, is that more or less -- this December level, is that sort of a good gross margin, you think, sustainable going forward?

Well, it won't be on pecans, as we mentioned, as Jeff mentioned. We expect walnut margins to improve. We expect almond margins to be stable and not much change in cashew or peanut margins, either, as they are at their normal levels. Mixed nuts probably won't improve too much, with the increase in pecan costs lately. So I think I've covered all the major nuts. Of course, macadamias will continue to maintain their superior margin.

As we focus once again on the consumer channel, whereas we haven't really been focusing that much due to industry conditions, based on your comments, I believe that that has a positive influence on your gross margin?

Yes, it does.

And your operating margin as well?

Yes, it does.

We've got some good news, finally. That's good.

I think as Jeff mentioned, the critical thing is distribution channel mix now going forward. As we noted, we did shift towards industrial, which is great for industrial, but it does have an impact on our gross margins. It's important to regain some of the levels of sales we had in the private label part of our distribution or consumer channel to get the margins back to normal.

I think I missed the number, but did you mention the difference -- this operating margin is what I care about -- the operating margin between industrial and consumer? Did you quantify that?

On the gross margin level, it ranges between about 5% and 7% in most years. On the operating side, it's probably just a little bit less than that range, because there's obviously more spending on the consumer side.

So certainly several hundred basis point improvement, if we could --

If I can get that sales mix shift back.

But of course, we may have some increased promotional spending as we try to get back some business?

Again, in the private label sector, for the most part, private label suppliers don't actually do the promotional spending; the retailer does, so -- although we do fund some of it. But it is important for retailers to get their margins back to be able to effect the promotional spending. Wouldn't you agree, Jeff?

Correct.

When we look at private label versus Fisher, I noticed some nice volume gains there. Is there a distinction in the margins between the two there?

Yes, there are.

Is Fisher better or worse than overall?

Overall, it's better than private brands' margin.

And I think you said we were getting some more penetration?

At Fisher, we're gaining more distribution, both in snack and baking.

And what is that a result of?

Result of promotional efforts on the baking side. On the snack side, it's new product launches. I mentioned the growth in the mixes, the trail mixes, in the category. We launched seven SKUs of what we call Fisher Fusions trail mixes in June of last year. So we are just gaining distribution with those new mixes, matching up with where the category growth is. In addition, we launched three SKUs of almond-specific flavors that are attributing to that growth as well, gaining distribution with the growth in the almond consumption category.

How many SKUs do you think you'll be launching in the upcoming 12 months, do you think?

For the next 12 months, we're looking at anywhere from six to nine new SKUs.

So that sounds like about what you have launched in the prior 12?

Correct.

But we think, with lower prices, we can increase the penetration there? Is that the hope?

Increase penetration, get more incremental sales through promotional efforts, correct.

Are they buying the stuff because it's a unique product or because we're able to kind of--?

Well, there's just an interest in flavors. You see a lot of -- the brand leader is launching a lot of new flavor profiles in the category. People are looking for that.

I'm just curious; I'm sure you have mentioned this before. But we keep alluding to this large customer that we lost last year. Can we say who that was? Was that Wal-Mart? Is that who that was?

We really don't acknowledge it publicly. What I will say, though, is it's a customer we lost in April of 2006. And major customers, when you've had a 15-year relationship, don't just turn the switch overnight. That's a loss that has occurred over the last couple years, 2004, 2005 -- just felt like we were neglecting their business, and they made a decision to move to a new supplier.

That's why, as of January of '06, we focused our sales and marketing efforts on damage control, in a way, making sure that got in front of our customers, we listened to them, understood what they wanted, what they needed to drive their categories. That's what we've done this past year, and we're starting to see the benefits of that going forward.

I guess you kind of saw this thing coming. Obviously, like you said, it was a multi-year phenomenon. Why do you think that you didn't -- basically, we had to go to a divorce before we went into marriage counseling?

There was a management change in the beginning of 2006, and prior to that, there were some issues in the sales and marketing departments. So it was something that the Company was unaware of at the time.

Also, I would point out, too -- Jeff made reference to this before but our major private label competitor also offered a program involving many different categories that also was a factor in us losing that business, too.

So that was going to be my next question. Who did you lose the business to?

We generally do not name competitors' names or customers' names in our calls, unless it has already been publicly disclosed.

Can you say who in general are your large private label competitors?

Well, there's obviously -- Ralcorp is a private label competitor. There are several sizable regional players in our industry that also do private label, for example, Ann's House of Nuts and some others in the Midwest.

Now, I think you said you were in discussions again with this customer. Do we have the chance to get back this business?

We do. I wouldn't say they are going to switch the plug back over on the snack category, the snack aisle, with cans and jars. But there's other snack items that we're discussing with them. There's other product lines that we're discussing with them as well.

Did we lose -- I mean, I understand neglect. But did it have to do anything with the reasons why we're building our new facilities, any kind of production issues? Or was it just--?

No, nothing with production at all.

Nothing with production or quality or anything?

No.

It was just sort of pissing people off?

No, not necessarily, Steve. I think, as Jeff said, that this particular customer was looking for some new ideas on how to grow the category, in addition to what I mentioned about the competitors' approach to getting the business. They felt it was time for a change.

In terms of the new facility, how much capital expenditure dollars do we have from today? Do we have less to spend before we are fully--?

It's approximately $5 million over the next two years.

That's it?

Right.

So we spent the bulk of the $100 million, was it?

Right, right. It's more than that.

More than that? Including capitalized interest, it's more than that?

Right.

So the heavy lifting is behind us?

Well, in terms of spending. But literally, the heavy lifting is actually ahead of us in respect to move existing equipment.

Well, yes. I mean, physically you've seen that. But technically, are there technical issues that we're concerned about?

No, I think we have a couple one-off lines that we have single-source production on that we're looking at either contingency plans of having copacked for us in the event that we do come across an issue. But typically, the new investments that we've made in equipment was to give us redundant production capabilities out in Elgin before we moved the line that was producing that like item.

Well, it's good news that we only have $5 million left to spend.

Yes, it is.

And we have made this far. Any more asset sales? Any more cash coming in the door from real estate sales at this point?

Well, as you may recall, we do have the original Elgin site that we hope to sell in the middle of summer. Then, of course, we're in the process of selling the almond equipment that was involved in our almond handling operation.

Can we say how much that will net us?

On the almond handling equipment, we're talking about a few hundred thousand dollars. Then, of course, as we've stated before, in the original Elgin site we believe we can recoup our investment, which is roughly about $7 million. There's some potential from upside there. But that's just difficult to quantify at this time.

Either year to date or the quarter, can you give me a sense of the mix between the consumer and the industrial channels? Did you say that?

I don't have that schedule in front of me, but I believe consumer is probably down -- and this is a second-quarter number only -- has probably dropped down from like 54% to 51%, again, in the context of pounds. Industrial, I think, jumped up from 21% to about 24% or 25%, again, in pounds.

So when we're talking about shifting mix between the two, we're talking a few hundred basis points of pounds?

Right, correct.

It's not going to be 10 whole percentage points, probably not?

No. But that is actually a pretty notable shift in sales mix, at least historically speaking. Usually, you see shifts of less than 100 basis points from year to year.

(OPERATOR INSTRUCTIONS). At this time, there are no further questions in the queue. I would like to turn the call over to Mr. Mike Valentine for closing remarks.

Since there are no further questions, we would like to, again, thank everyone for participating in our conference call and their interest in JBSS. At this point in time, this concludes the call for our second-quarter operating results. Again, thanks, everyone, for participating in our call.

Ladies and gentlemen, this concludes the presentation. You may now disconnect, and have a great day.