John B Sanfilippo & Son Inc (JBSS) 2016 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the John B. Sanfilippo & Son Incorporation second-quarter fiscal 2016 operating results conference call. (Operator Instructions)

And I would now like to turn the call over to Michael Valentine, Chief Financial Officer.

Thank you, Lauren. Good morning, everyone, and welcome to our 2016 second-quarter earnings call. Thank you for joining us today.

On the call with me today is Jeffrey Sanfilippo, our CEO, and Jasper Sanfilippo, Junior, our COO. Before we start, we want to remind you that we may make some forward-looking statements today. These statements are based on our current expectations and they involve certain risks and uncertainties. The factors that could negatively impact results are explained in the various SEC filings that we have made, including Forms 10-K and 10-Q. We encourage you to refer to these filings to learn more about the risks and uncertainties that are inherent in our business.

Turning to the income statement, net sales for the second quarter of fiscal 2016 increased by 11% to $279 million in comparison to net sales of the second quarter of fiscal 2015 of $251.4 million. The increase in net sales was attributable primarily to a 9.4% increase in sales volume, which we measure as pounds sold to customers.

Sales volume increase in all four distribution channels in sales volume increased for all major product types, except almonds and pecans. The increase in the consumer channel volume was primarily attributable to increased sales of private brand peanuts and mixed nuts to existing customers. A 20.7% volume increase for Orchard Valley Harvest and Sunshine Country produce products also contributed to the sales volume increase in the consumer channel. Fisher recipe nut volume decreased by 1.1%, primarily due to the unfavorable impact of higher retail prices of consumer demand for almonds and pecans. Fisher snack nut volume declined by 10.3%, primarily as a result of reduced merchandising activity. Promotional events that occurred in second quarter of fiscal 2015 that will not occur until third quarter of fiscal 2016 also contributed to the decline of Fisher's snack volume.

The sales volume increase in the commercial ingredients channel came primarily from increased sales of bulk peanuts to other peanut shellers, and the increase in sales volume in the contract packaging channel was generated by increased sales of peanuts and trail mixes to existing customers. Sales volume rose in the export distribution channel, mainly due to increased sales of bulk and shell walnuts.

Net sales for the first two quarters of the current fiscal year increased to $504.8 million from $456.4 million for the first two quarters of fiscal 2015. The increase in net sales and year to date comparison was primarily attributable to a 5% increase in sales volume. Higher selling prices for all major product types except peanuts and walnuts also contributed to the increase in net sales. Sales volume was relatively unchanged in the consumer distribution channel, and sales volume increases for our branded produce products, Fisher peanut butter, and Fisher Nut Exactly snack bites fully offset a sales volume decline in private brand products in the consumer channel.

Sales volume increased significantly in the commercial ingredients, contract packaging, and export channels, primarily for the same reasons noted in the quarterly comparison.

Second-quarter gross profit increased by $7.8 million, and gross profit margin as a percentage of net sales increased to 16.1% compared to 14.8% for the second quarter of last year. The increase in gross profit in the quarterly comparison primarily resulted from increased sales volume and the increase in gross profit margin was mainly attributable to improved alignment of selling prices and commodity acquisition costs. Gross profit for the first two quarters of the current fiscal year increased by $10.3 million, while gross profit margin as a percentage of net sales increased to 15.5% from 14.9% for the first two quarters of fiscal 2015.

The increase in gross profit for the year-to-date comparison also mainly resulted from increased sales volume. The increase in gross profit margin in the year-to-date comparison was again mainly attributable to improve alignment of selling prices and acquisition costs.

Total operating expenses for the current second quarter increased slightly to 9.1% of net sales from 9% of net sales in the second quarter of 2015, while total operating expenses increased by $2.8 million. The increase in total operating expenses was due to increased compensation expenses.

Total operating expenses for the current year-to-date period decreased slightly to 8.9% of net sales from 9% for the first two quarters of last year. And, total operating expenses increased by $3.5 million. The increase in total operating expenses in the year-to-date comparison was also due to increased compensation expenses.

Interest expense for the current second quarter was $800,000 compared to $900,000 for the second quarter of last year. Interest expense for the first two quarters of the current year decreased to $1.7 million from $1.9 million for the first two quarters of last year. The decreases in interest expense in both comparisons were primarily attributable to a reduction in long-term debt.

Net income for the second quarter of fiscal 2016 was $12.1 million or $1.07 per share diluted compared to net income of $8.4 million or $0.75 per share diluted for the second quarter of last year. And net income for the first half of fiscal 2016 was $20 million or $1.77 per share diluted compared to net income of $14.3 million or $1.28 per share diluted for the first two quarters of fiscal 2015.

Taking a look at inventory, the total value of inventories on hand at the end of the current second quarter decreased significantly by $36.7 million or almost 17%, compared to total inventory at the end of the second quarter of fiscal 2015. The decrease in inventory was primarily driven by lower quantities of raw nut and dried fruit input stocks and significantly lower estimated acquisition costs for walnuts. The 10.2% reduction in the quantity of raw nut and dried fruit input stocks in the quarterly comparison resulted from lower quantities of pecans, peanuts and walnuts.

Finally, the weighted average cost per pound of our raw nut and dried fruit input stocks on hand at the end of the second quarter declined by 14.9%, mainly due to the decline in our estimated walnut acquisition costs.

And now, I will turn the call over to Jeffrey Sanfilippo, our CEO, who will provide additional comments on our performance in the current quarter. Jeff?

Thank you, Mike. Good morning, everyone.

As you have read in our press release and heard from Mike, great results. I am very proud of our management team and every one of our 1,400 Associates for their leadership and efforts to drive our Company performance and achieve record second-quarter earnings for the fourth consecutive year.

We had a strong quarter in respect to sales volume across all of our business channels. This included a return to sales volume growth in the commercial ingredients and international distribution channels. These results are especially meaningful when you take into account this was another quarter where sales volume for almonds declined significantly due to higher prices.

Overall, our brand performance for the quarter was strong compared to the nut category at retail in the consumer channel. Distribution gains for Orchard Valley Harvest and Sunshine Country produce products on a combined basis helped drive our overall growth. For Fisher recipe nuts, though our sales volume was down slightly in the quarter, Fisher outperformed the recipe nut category at retail with only a 0.05% decline in pounds, while pounds for the entire category declined by 7.7%, according to IRI data.

For Fisher snack nuts, it was a challenging second quarter as they underperformed in the snack nut category at retail with an 18.2% decline in pounds, while pounds in the entire category declined by only 0.9%. The sales volume decline was attributed to a lack of promotional activity at a major customer, which Mike mentioned. A key focus for our sales and marketing team is to diversify our customer base for Fisher snack nuts.

On a positive note, if we look at our core geography in the Midwest and exclude the one major customer decline, our Fisher snack brand actually increased 17% in dollars, while the category only grew 4.8% in the Midwest. For the remainder of fiscal 2016, and the first two quarters of fiscal 2017, acquisition costs for almonds and walnuts should decline significantly. These declines in acquisition costs are expected to lead to lower selling prices for products that contain those commodities.

Since sales of almonds and walnuts comprise such a significant percentage of our total net sales, we anticipate that lower selling prices could result in a reduction in total net sales in future comparisons until the impact of lower retail prices ultimately drives increased sales volume for these products.

Just as we have demonstrated our ability to overcome volatile markets over the past four years as nut prices increase to record highs, we would do the same as prices for commodities such as walnuts and almonds decline. Our sales and marketing teams are already working on programs with customers to manage significant price declines while maintaining strong topline segment sales. In addition, we expect to see a reversal in the decline of almond consumption, particularly as prices come down.

It is important to note that, in spite of volatile commodities and financial markets, we are on our way to another record year for the Company. Our procurement, demand planning, production, and sales teams are laser focused on managing our inventory positions.

Turning to a sales review by business channel, in consumer channel overall, strong results. Net sales in the consumer channel increased by 9.1% in dollars and 2.5% in sales volume the second quarter of fiscal 2016 compared with the quarter fiscal 2015. Our consumer sales and marketing teams are focused on diversifying our Fisher snack distribution to mitigate the volatile impact on volume due to high customer concentration, as I mentioned.

In the commercial ingredient channel, net sales increased by 11.6% in dollars and 20.7% in sales volume. The sales volume increase for the quarterly comparison was due to increase in sales of peanuts, as Mike mentioned. This was done partly to balance our inventory position at the time. The sales teams in this channel continue to focus on building our Fisher brand in food service, working with key private brand partners in developing new value-added partners to diversify the customer base.

Net sales in the international distribution channel is relatively unchanged in dollars and sales volume increased 29.3% in the second quarter of fiscal 2016 compared to the second quarter of 2015. The sales volume increase in the quarterly comparison was primarily due to increased sales of bulk and shell walnuts.

In the contract packaging channel, as was the case in the first quarter of fiscal 2016, sales volume growth in the contract packaging channel contributed meaningfully to our overall sales volume growth in Q2. Net sales increased by 23.5% in dollars and 16.2% and sales volume in the second quarter of fiscal 2016. The sales volume increase was primarily due to increased sales of peanuts and trail mixes to existing customers.

We continue to provide valuable innovation and manufacturing expertise to our key partners in this channel, and they have been successful in gaining distribution and launching new products in the market.

Now turning to category updates for the snack, recipe and produce segment, and a review of our brand performance during our second quarter. As always, all the market information I will be referring to is IRI reported data for the 13-week, the period ending December 27, 2015. When I refer to Q2, I am also referring to that same 13-week period.

References to change in volume or prices are versus the corresponding period one year ago. We look at the category on IRI's total US definition, which includes food, drug, mass, Walmart, military and other outlets unless otherwise specified. And when we discuss pricing, we are referring to average price per pound. The term velocity refers to the sales per point of distribution.

First, let me review some category dynamics. For the quarter, we saw increase in dollar sales and a decrease in pound volume. This is the result of general higher retail nut prices, which is impacting consumer purchase behavior. The total nut category increased in sales dollars 2% and declined in pound volume 2% in Q2.

Overall, prices in Q2 increased 4% versus the prior year. Almonds and cashews experienced the largest price increases. Almonds increased 17% and cashews increased 6% versus Q2 last year, and that resulted in a 13% pound sales decline for almonds, while cashews actually increased 5% in pound sales. Interestingly, cashews were 14% less expensive than almonds and it is possible that some consumers have switched to cashews from almonds.

Now I will talk about each category in a little more depth, starting with recipe nuts. In Q2, the recipe nut category decreased 3% in dollar sales and 8% in pound sales, driven by an average price increase of 5%. The decline was led by 26% increase in almond prices, along with a 3% increase in pecans. Average walnut prices -- retail prices decreased 1%.

In relation to total category performance, our Fisher recipe brand had a very strong quarter and continues to build on our previous momentum. The Fisher brand continued its sponsorship of the Food Network and celebrity chef Alex Guarnaschelli. The program includes refreshed branded vignettes on the Food Network, print advertising in Food Network Magazine, and other publications, as well as a fully integrated social media effort.

We also continued messaging around our no preservatives product benefit, which we started last holiday season. The no preservatives claim is on trend and has helped distinguish the Fisher brand in the marketplace. Our brand equity efforts on Fisher helped the brand gain share leadership in Q2 across IRI's multi-outlet geography.

Furthermore, Fisher recipe nuts increased 8% in dollars sales and decreased slightly in pounds versus last year, despite the challenging category landscape. As a result, Fisher's share of the category increased 1.8 points versus last year. Distribution gains were a key driver of brand growth as total points of distribution increased 9% versus a year ago.

Now, let me turn to the snack category. In Q2, the snack category increased 6% in dollars and decreased 1% in pound sales versus last year. Average prices were up 7%, led by almonds at 16%. Fisher snack decreased 16% in sales dollars and 18% in pound sales in Q1 as a reason -- as due to the reasons I mentioned earlier.

In the produce category, total produce nuts decreased 1% in dollars and 3% in Q2 versus last year. As we described in the last earnings call, we are transitioning our Orchard Valley Harvest business to Sunshine Country at a major retailer. As such, we look at our produced nut business as a combination of the two brands. Our total produce business of Orchard Valley Harvest and Sunshine Country increased 9% in pounds sales versus last year. A significant increase in our total points of distribution, up 158%, is driving the sales increase.

We will continue to update you on the sales results of this transition in future calls.

In closing, while we face many challenges that impact our Company, we have proven our ability to manage through difficult markets and regulatory changes to mitigate the impact on our financial performance. We will continue to work closely with customers to provide value and help them continue to build their nut and snack programs. Our record year-to-date results demonstrate a commitment by the Company to provide relevant, profitable, value-added products and services to our customers and consumers.

These results also demonstrate the success of our strategy to grow our brands. The management team remains focused on consistent execution of our corporate goals to create customer and shareholder value. And our strategic goals remain consistent: growing Fisher and Orchard Valley Harvest into leading nut brands by focusing on consumers, demanding quality nuts and the snacking, recipe and produce categories, expanding globally and building our Company into a leading international branded and private brands snack Company and providing integrated nut solutions to grow nonbranded business at existing key customers in each distribution channel.

We appreciate your participation in the call and thank you for your interest in our Company. I will now turn the call back over to Mike.

Thank you, Jeff. We will now open the call to questions from participants. Lauren, which you be kind enough to please queue up the first question?

(Operator Instructions) Francesco Pellegrino.

Thanks in advance. Obviously there's a lot of moving parts to this quarter, always seems like that every time you guys report a record quarter. But, I just wanted to start off with the really impressive performance of Orchard Valley Harvest and Sunshine Country. The 21% increase, could you sort of put that in relation to maybe what it represented overall as a percentage of the Companywide 9.4% overall volume increase (technical difficulty) percentage, was it a small percentage?

Give me a moment here, Francesco.

I always start off with a tough question.

I would say overall, it represents almost about 10% of the total volume increase.

While Mike is looking at specific numbers, this is Jeffrey. So the sales and marketing teams have done a great job on really finding the right product mix, the right pack sizes in the produce channel with our Orchard Valley Harvest brand, Sunshine Country. So we -- the Orchard Valley Harvest brand is our premium produce brand, our non-GMO, no preservatives and it is really just perfect for that consumer looking for health and wellness in the produce category. And we've also had some success expanding it beyond just the produce category, which is exciting news and partly attributes to the increase in the volume.

And then our Sunshine Country produce brand is really focused as a lower tier brand, something where we can the more competitive from a pricing standpoint and that has been extremely successful as we have launched that.

(Operator Instructions) Mr. Pellegrino, your line is now open.

So back here again, Jeffrey, the only reason why I brought it up was, I know you don't break out the brand. And usually when you start seeing increases in volumes for these types of brands off of a small base, it is really not that impressive.

But this 21% increase for these two brands, it sort of seems as if it is becoming more of a sizable part of your branded business. Is that correct?

That is correct. And it is a big focus for our organization, absolutely.

Okay. I noticed another thing you guys spoke about in the release from yesterday. Is this phenomenon of your peanut shelling operation selling peanuts to other peanut shellers? What's behind that?

There's actually two things behind it. First of all, we are shelling basically 40% more than what we have shelled in recent years, so we are generating more peanut crushing stock, peanuts that are intended to crush for oil. So that lifted sales in the commercial ingredients channel as a result of that.

And then the second part is, we also -- when you buy peanuts, they are basically segregated into three categories, and two of those categories are peanuts aren't suitable for human consumption without further processing and conditioning. Normally, we will perform that, and use those peanuts after those additional processing steps.

But because we are selling so many peanuts and we are shelling so many more peanuts than we normally do, we do have to sell some off to other shellers. So overall -- and that part of sales of farmer stock peanuts accounted for roughly about 20% of our total volume growth in the quarterly comparison.

This different type of peanut that you are shelling, is it a superior or inferior grade compared to just I guess your -- what is it, the Virginia peanut?

No, no, it's -- I am talking about runner peanuts here, and they are neither superior or inferior to any other variety. In fact, they are the most common variety. It is just our increased shelling volume and our increased peanut purchases have and will result in additional peanut sales volume to other shellers.

You keep on talking about the increase in the shelling volume. I would think that your peanut shelling operations would be a low margin business that, as you take on more and more volume, you are able to create greater operational leverage. Is that a correct way of thinking about it?

Sure. When you increase the amount of peanuts you shell by 40%, it is going to have a meaningful fixed costs absorption benefit.

All right. You guys had mentioned also some reduced merchandising activity. That did not occur in Q2 fiscal 2016 that did occur in the year ago period. Is this like the trade spending that you guys incurred last year of $2.2 million, or is this just an additional different type of expense?

No, that is exactly what it is. When we look at our Q2 of last year, a little bit overspent on trade in some key customers, so this was a result of looking at our trade spend overall and trying to mitigate any kind of big increases that we saw last year this time.

So if you are going to be pushing this trade spending into the third quarter, will it have maybe more of a focus on maybe Fisher snacks since it underperformed the category so significantly? I would not think it is private-label business. What direction will this elevated trade spending that you are pushing out into the 3Q really be directed towards?

So, we anticipate similar spending that we saw in Q3 of last year. Some of the volume decline, a lot of it was attributed to promotional activity that didn't occur in Q2. Some of that we do expect to see in Q3. But I would anticipate similar trade spend for Q3 and Q4 going forward.

And just to clarify, Francesco, the timing issue here is related much more to merchandising than it is to promotional activity. So we just did not get the kind of display activity that we got last year, and that will occur with one major retailer in Q3.

Okay. I know you made some comments about the performance of those Fisher snack nut declining in the category greater than your peers. I know you mentioned that it happened at a significant -- at a single customer. Is there an ability to get this business back? What really caused the customer to switch away from the Fisher snack nut product at the location?

We still have the major customer. A lot of it was due to buyers in the category for example not adding so many peanut promotions in a given period. So some of that was just a different direction of the retailer took to the category, for the quarter. Some of it was the promotional activity that I mentioned that we pulled back on, the trade spend, had a little bit of an impact on the volume that we saw in that quarter.

So, some of it is timing. Some of that is promotional trade spend. Some of it was just the direction the retailer took at that time period. And so, we anticipate, obviously as Mike mentioned, from a timing standpoint on that promotional activity, seeing some of that come back in Q3.

So, just let me get this straight. If I am thinking about this correctly. Overall Fisher's snack nut performed worse than the overall category. But when you isolate at these certain retail locations, you are not necessarily underperforming to the degree in which you were for the overall category, but everyone at the single retailer just wasn't pushing promotions across the board.

Correct.

And they work moving through different products, so if you are an end cap at an aisle of nuts, they were moving to something else like I don't know, some other healthy indulgent alternative. Is that a correct way of sort of interpreting it?

Yes, that is exactly right. If you were to take the Midwest, for example, is one of our core markets, if you pulled out this one specific customer from that market, actually our Fisher snack sales were 20% higher -- 20% growth versus the category was only 4.4% growth.

So, taking out that one customer, we are still having success in building our Fisher snack program ahead of the category. The goal really is to diversify that customer base and get less reliant on one to two major customers and find much better distribution, more retailers that won't have sort of -- so if we do have a hiccup with one customer, it doesn't hurt our brand as much from a volume standpoint.

But it seems as if this could be an easy fix for 3Q as it was just more of a timing thing.

Yes, I would agree with that.

Okay. Jeffrey, you spoke about impact that lower almond and walnut prices could have. Sort of avoided the high pecan pricing. You guys are vertically integrated for that. What could we really start expecting with high pecan prices? Is there an opportunity maybe for consumers to transition consumption patterns through different type of nut? I would just think that elasticity is really being pushed right now.

Yes, you're absolutely right. And if you look at the almond volume and almonds prices, you are starting to hit that threshold where consumers are shifting from almond consumption to other snacks, other nuts specifically. We believe that as we look at the rise in cashew consumption, the almond industry is losing some of those consumers to cashews because of the higher retail prices. And so, we see that both in the recipe category as well as the snack nut category. So with a higher price for pecans, you can anticipate some lower consumption trends in pecans, both in mixed snack mixes as well as in the recipe category. What our sales teams are focused on is really obviously as almond prices and walnut prices come down, working with our key customers, because they are just as concerned as we are with topline revenue.

And so, looking at upsizing some of the bags, looking at other promotional activity that we can enhance to drive volume for those nut types, and our sales and marketing teams are working closely on doing that now.

Okay. And lastly I want to ask, you are vertically integrated for pecans, so we do you see yourself getting aggressive in your pecan purchasing activity, especially with how elevated this part of the market is?

Sure, so the market -- the harvest really started September/October. We are in January now, so the harvest is actually almost finished. The harvest was a little bit earlier than normal. And so, we will be buying a little bit more through February into early March and then we will be done. And so that procurement is almost -- we are probably about 90% finished at this point.

Okay. And just the last thing I want to discuss with you guys, because it seems like this might not have been a position you really have ever been in since you consolidated your operations in [allogeneic] and created a bunch of different synergies. But the free cash flow you guys have generated in the first half of fiscal 2016 is about $6.25. Usually in the first half of the year, you generate some nice free cash flow which is then offset substantially in the third quarter as you finance your inventory purchases.

This -- I know you put a cautionary twist on the almonds and walnut prices coming in and how it is going to just -- the changes it is going to do in your average blended selling price, your average cost per pound. But it seems as if for the first time in maybe quite some time you are going to be generating some significant free cash flow in the third quarter. And you are generating significant free cash flow in the third quarter if you are being able to finance lower inventory purchases at lower costs, and you could really be driving some really nice free cash flow in fiscal 2016.

I guess my question for you is, what is going to be the priority of your usages of cash? I know always paying off the revolver is going to be one of them, but you only have $13 million outstanding on your revolver. You always do a nice special dividend, but you do a nice special dividend every year, always looking at acquisitions. Just maybe want to hear what you guys are thinking about, priority usages of cash going forward.

First, Francesco, we don't anticipate having positive cash flow in the third quarter. We never do.

I think a better way to characterize that is our negative cash flow that typically occurs in the third quarter will be lower than it has been in recent years. That's probably a better way to look at that.

But you are correct when you think about it further out that, at least for the next few quarters, lower almond and walnut prices will probably result in better cash flow than we have seen last year. So, that will ultimately manifest itself in the lower loan balance over the next couple quarters than we saw last year.

And then, of course with that additional borrowing capacity, we have to make some decisions and look at options on how to use that capacity, whether that is to increase our investment in maybe CapEx, possibly a higher dividend, or you know, higher M&A.

And in regards to M&A, anything out there or maybe different category penetration that you would be looking at? Is it just a nut business or would you expand into maybe some different ventures, like you saw Snyders Lands take out Diamond. They are taking on the net segment of Diamonds operations, something they are not really that familiar with. We're seeing a lot of companies sort of going outside of their comfort zone. How willing are you guys to expand outside of nuts?

This is Jeffrey, Francesco. So we are always looking at M&A activity. We are aware of businesses that are up on the market or are going to be coming to market, so something that we are very, very interested in pursuing. We just haven't found the right deal for the right business yet.

When you look at the space, salty snacks base continues to grow. We look at the popcorn next to nuts. As a result of what we saw in popcorn, that is one of the reasons we launched the Nut Exactly brand to try to expand the portfolio from just nuts to other salty snacks.

We look at the nut butter category, which is continuing to grow as well at opportunities. And then the bar category, the snack bar category is another area that we look at that is growing, somewhere where there is a nut is an inclusion in the product, but something else that also category growth where we see in the future. So those are the type of M&A things we look at and the categories.

Okay. Going to be interesting to see how this occurs, but I appreciate the time, guys. Thanks again.

There are no other questions in queue.

Okay, Lauren, thank you. Again, we want to thank everybody for their interest in JBSS and this concludes the call for second-quarter 2016 operating results.

Ladies and gentlemen, thank you so much for your participation in today's conference. This concludes the presentation and you may now disconnect. Have a great day.