Sunopta Inc (STKL) 2005 Q2 法說會逐字稿

Good day, everyone. Welcome to the SunOpta Inc. second quarter 2005 earnings results conference call. Today's conference is being recorded. At this time, I'd like to turn the call over to Mr. Jeremy Kendall, Chairman and Chief Executive Officer. Please go ahead, sir.

Thank you very much. Good morning, ladies and gentlemen and welcome to the second quarter 2005 investor call for SunOpta Inc. I'm joined on this call today by Steve Bromley, the Company's President and Chief Operating Officer, John Dietrich, the Company's Vice President and Chief Financial Officer, Sergio Varela, Vice President of Operations and Business Development and newly appointed President of the SunOpta Fruit Group, and Ben Chiba, Vice President and Corporate Counsel.

Before I begin, I would like to remind listeners that except for the historical information, the matters discussed during this conference call may include forward-looking statements, including statements relating to 2005 operating results that may involve a number of risks and uncertainties that could cause actual results to differ materially. These risk factors are detailed in the Company's filings with the Securities and Exchange Commission. Please note that our financial results are reported in US dollars and in accordance with the US GAAP. A reconciliation to Canadian GAAP will be available in the notes to the Consolidated Financial Statement, which will be filed with our 10-Q for the period ending June 30, 2005 later today.

We are pleased to report revenues for the second quarter of 103 million, our first quarter with revenues in excess of $100 million mark. The 27% growth in revenues over the prior year was assisted by strong demand for grain products; in particular, sunflowers, organic sweeteners and soy powders, strong demand for our aseptically packaged goods, and the impact of acquisitions that we completed in late 2004. These factors are partially offset by the impact of the decline in low-carb diets on our fiber operations.

Internal growth in the first quarter was 12.8% and acquisitions contributed 14.3%. Revenues in the second quarter exclude any significant revenues from the recently acquired businesses and consequently, even though the second quarter is cyclically our strongest quarter, we fully expect future quarters to continue to exceed 100 million in revenue.

Moreover, revenues in the second quarter include any revenues related to the Steam Explosion equipment contract announced yesterday. We had hoped to announce this contract a number of weeks ago. However, it was only yesterday morning that the contract was finally signed by all the required parties within Abengoa. Thus, the press release at the close of business yesterday coincided with our earnings release. We felt that due to the significance of this contract, it merited its own press release.

Revenues for the 6 months ended June 30, 2005 were $189 million, a 31.8% increase over the first 6 months of 2004. This increase in revenues for the 6 months period reflects strong growth in grains and packaged products, partially offset by lower growth rates in ingredients and distribution.

On a year-to-date basis, internal growth rate was 12.8%. Given the weakness experienced in our fiber business on a year-to-date business, we are very pleased with this growth. Based on the projections for our existing businesses, combined with the recently announced acquisitions, we are now raising our revenue guidance for fiscal 2005 from 385 million to 415 million. This is a reflection of the strong growth we're experiencing in most parts of our business.

We continue to target a revenue exit rate for 2007 of $1 billion. We believe that this level of revenue will enable our company to benefit from economies of scale in addition to the ability to reduce the impact of costs related to the company's public status. We expect to be able to reach this target by expanding our existing operating segments through a prudent combination of internal growth and acquisition. We do not expect to enter into any new operating segments, but intend to stay focused on the areas within which we are operating.

Our operating segments reflect today's healthy eating trends and the USDA's new dietary guidelines, which call for increased consumption of fruits, vegetables, whole grains, fiber, and plant oils, including soy, corn, and sunflower oil, with varied market segments to which we are focused. With the completion of the recent acquisition of Cleugh's Frozen Foods, Inc. and Pacific Fruit Processors, Inc. and the announcement of our new operating group in July, the SunOpta Fruit Group, we will expand our segmented reporting in the third quarter financial statement.

Net earnings after minority interest for the second quarter were 3.3 million or $0.06 per diluted common share. Net earnings after minority interest for the 6 months ended June 30, 2005 were $9.9 million or $0.17 per diluted common share. Excluding onetime items in minority interests, year-to-date earnings in 2005 were $5.9 million compared to $6.2 million in the same period in 2004.

The earnings reflect the decline in fiber and distribution margins, offset by increases from grains and packaged products and acquisitions completed in late 2004. The good news, however, is that we experienced a very good momentum in June, and as we enter the back half of 2005, there are numerous new products, projects and customer contracts in the works, which are expected to result in a strong second half. Steve Bromley will detail these activities later in this call.

Our effective tax rate for the quarter was 28%, which is within our normalized guidelines of 26% to 31%, dependent upon business mix and the impact of tax planning strategies. The company's balance sheet remains strong as of June 30, 2005 with 7.7 million in cash and sufficient resources to continue to fund operations, investment capital projects and fund future growth. Shareholders' equity was 153.5 million, representing a book value of $2.72 per common share, up from $2.67 at March 31, 2005.

In the second quarter, the company acquired Cleugh's Frozen Foods. Cleugh's is a large processor of natural and organic strawberries and other fruits, which are primarily harvested between April and July, frozen, and sold evenly throughout the year. As a result, Cleugh's draws on an existing line credit facility, primarily during the second quarter, to fund inventory purchases, which is the seasonal high. In 2005, Cleugh's had additional borrowing availability in excess of $10 million to fund further inventory purchases.

Long-term debt increased to $39.8 million for SunOpta, primarily as a result of acquired debt and debt to fund acquisitions. Long-term debt to equity ratio is at 0.26 to 1 at June 30, 2005 and remains low.

As I mentioned earlier, we finally released confirmation of the receipt of our first StakeTech Steam Explosion technology equipment contract with Abengoa. This contract includes the supply of technology and equipment to Salamanca, Spain, where Abengoa currently operates a wheat to ethanol facility. The Steam Explosion equipment will be fabricated in North America and installed alongside this Abengoa Spanish facility for the purpose of processing wheat straw into ethanol, thus utilizing the entire wheat plant and reducing waste. We believe that this will be the first such facility in the world and will be key to expanding the supply market of ethanol, which is currently limited by the availability of corn and wheat. We expect to sign a second contract with Abengoa this quarter to supply Steam Explosion equipment for a corn stover to ethanol facility in York, Nebraska. This will be located beside an Abengoa facility, producing ethanol from corn cobs.

Ethanol is clearly a hot topic today, as environmental concerns, dependency on mid-eastern oil, and the high price of crude oil are encouraging some 13 different states and provinces to legislate between 10% and 20% ethanol inclusion in gasoline. These Steam Explosion technologies facilities are scheduled to be commissioned by mid-2006. Once the facilities are operational and the technology can be demonstrated, we expect to generate significant interest for additional and potentially larger equipment sales.

We are very fortunate to be partnering with Abengoa, the largest ethanol producer in Europe and the second largest in the world with multiple facilities in Europe and North America and aggressive expansion plans.

I'd now like to introduce Steve Bromley, President and Chief Operating Officer of SunOpta.

Thank you, Jeremy. I'm pleased to provide further details on activities within our businesses. During the quarter, we completed 3 transactions in our food business and 1 in our environmental business. In early July, we completed another acquisition in the food business, thus completing our vertically integrated fruit model. In early April, we purchased the remaining 49.9% of the outstanding shares of Organic Ingredient Things. We had initially acquired 50.1% of this business in September 2004. Organic Ingredients forms the base of our newly created vertically integrated fruit model. This business continues to perform well and brings extensive domestic and international sourcing and private label expertise to SunOpta. Organic Ingredients supplies a number of private-label products to customers such as Trader Joe's, UNFI and others.

On May 31, 2005 we completed the acquisition of certain assets of earth wise processors in Moorhead, Minnesota. Earth Wise is a vertical integrated producer of organic and identity preserved non-GMO grains with the primary focus on soy. Strategically, this acquisition provides SunOpta with an expanded and diversified grower base, expansion of soy product offerings and significant operating synergies. The operations of Earth wise have been integrated with our grains and soy products group and the business has performed to expectations thus far.

On June 17, 2005 we acquired 100% of the outstanding common shares of Cleugh's Frozen Foods, Inc. of Buena Park, California. Cleugh's is a third-generation family business focused on processing natural and organic frozen fruits and vegetables for the retail private-label food service and industrial markets operating from two California-based facilities. The acquisition of Cleugh's represented a key building block in the development of our vertically integrated fruit business, providing extensive processing and packaging capabilities.

On July 13, 2005, we announced the acquisition of 100% of the outstanding shares of Pacific Fruit Processors Inc. located in South Gate, California, a suburb of Los Angeles. Pacific is a manufacturer of value added fruit products with a focus on fruit based ingredients for the dairy, bakery and berry industries, industries to which we are very familiar. The company offers custom formulated fruit-based ingredient solutions for a wide range of specialized applications. The company's extensive R&D capabilities will be a key driver for continued growth. Organic fruit ingredients represents the fastest-growing part of Pacific's business.

As a result of the acquisitions of Organic Ingredients, Cleugh's and Pacific, we have formed a new operating group, the SunOpta Food Group. These vertically integrated businesses form a platform from which the company can emerge virtually any food specifications for its retail, food service, and industrial customers. On a combined basis, the group has annualized revenues of approximately $100 million, a level we feel is important in order to develop economies of scale and leverage operating synergies. In order to drive the integration and development of this group, maximizing market opportunities and cost savings, we were pleased to announce the appointment of Sergio Varela as President of the SunOpta Food Group. Sergio is well-suited to lead this exciting business based upon strong financial and operating capabilities.

The Organic fruits market in the US is now over $14 billion and continuing to grow. In hand with the growth in this market was the increased demand for private label organic products. With the establishment of the Food Group and our current presence in the private label soy, fruit bar, and seed products segments, we are now a major player in this market. We intend to continue to expand our capabilities and expertise in this area.

The grains and soy products group results remain strong in the second quarter. Revenues in the quarter increased by 13% to a record $27.8 million and segment earnings increased by 67% to $2.3 million. In the first 6 months, revenues increased by 15% and segment earnings by 85%. The primary growth driver has been the sunflower business, which has generated strong margins and record sales. In June and July, we contracted additional sunflower crop from Texas growers to ensure continued supply of high-quality products to our customers. This additional volume will enable our production facilities to remain at near capacity through the northern harvest in September and October.

SunOpta's contract with sunflower growers have increased by 30% in the US and 300% in Europe in 2005. Our European venture has been profitable this year and SunOpta has an option to acquire this business at an agreed upon price. We intend to grow our international presence in the global confection and sunflower industry, a market we feel offers excellent opportunity and is consistent with our intentions to provide healthy food products. Our objective is to become one of the largest -- to become the largest sunflower -- confection sunflower company in the world, with revenue in the $100 million range within the next two years.

Soy and corn prices and supply remain relatively stable in the second quarter, as we expect to have an above average -- an average to above-average year in 2005. Our crops look good so far this year. The majority of our growing areas have not been impacted by growth conditions, which have affected several regions of the US. We continue to believe that soybean rust will not be a major issue this year in our growing regions and remain confident that actions taken by growers to reduce this risk have been successful. We are currently pursuing a number of new soy powder accounts in Europe and Japan. We expect to secure some of these large accounts by the end of this fiscal year, which will significantly increase our soy concentrate and powder production.

SunOpta Ingredients Group revenues increased by 49% in the second quarter, while segment earnings declined by 27%. In the first 6 months, revenues increased by 39%, while segment earnings declined by 32%. The increase in revenues primarily reflects the inclusion of Organic Ingredients, an acquisition completed in September 2004, while the decline in segment earnings reflects the significant decline in oat fiber sales and margins from last year's second quarter, which was the peak of the low-carb diet craze.

In the first quarter call, we announced 4 specific actions to counteract the decline in fiber sales. I would like to provide you with an update on these action plans. We announced that we've hired an international sales manager to expand international sales. The new sales manager has held a number of strategic meetings with our existing international distributors to develop aggressive new sales plans for Europe and Australia and has met with new distributors in South America, the Middle East, and Asia.

We continue to aggressively pursue market share in these regions and expect to generate continued positive momentum. Initial new sales have been made and we expect good progress in the second half. We announced that we were refocusing our R&D and applications teams to broaden our fiber portfolio. Three weeks ago at the IFT trade show in New Orleans, we launched 2 new fibers-- organic oat fiber and organic soy fiber, our first foray into soy fibers. We expect to generate the fruit sales of these products in the coming months and will continue to focus our R&D teams on further expanding our fiber portfolio. We announced that we were refocusing our marketing and sales efforts to develop new markets.

In the second quarter, the company has secured a number of new fiber accounts for crackers, biscuits and pet foods, markets in which the company was not previously a big participant. We'll continue to expand our marketing efforts in these and other industries. We announced that we were expanding our sales efforts in the growing fiber enriched and whole grain markets. We continue to expand our efforts in these markets and have been aggressively pursuing a number of new accounts. We expect to benefit from these actions in the fourth quarter. There is no question that the decline of the low-carb diets impacted our business. But these new initiatives are paying off and we expect solid improvements in our fiber operations going forward.

In fact, June was the strongest month for fiber thus far this year. Our bran and germ facilities in Cambridge, Minnesota is now performing well and we are experiencing increased demand as a result of increased sales efforts. In July, we commissioned both soy yield improvement equipment and the Okara (ph) drying processing equipment and our ingredients facilities in Alexandria, Minnesota.

The soy yield improvement project has increased our soybean-processing yield by 6 to 8%, while the Okara project has turned the cost of disposal of byproduct into a profit generating activity. Both of these projects are expected to generate immediate financial benefits to the company. Sales of soluble fiber, marketed by third parties under the brand names Benefiber and Sunfiber, also performed very well in the quarter, with our current equipment configuration performing near capacity.

As a result, we're assessing further capital expansion to increase output by up to 50% by the end of this year. Packaged products group revenues in the second quarter increased by 20% to 13.2 million, while segment earnings increased by 3% to 508,000. In the first 6 months, revenues increased by 31% and segment earnings increased by 123%. The increase in revenues in earnings is primarily attributable to the strong demand for aseptically packaged products, including soy, rice, and tea drinks.

Our aseptic facility continues to operate well, averaging in excess of 100,000 cases produced per week. We continue to pursue a number of exciting growth opportunities in hand with continued process improvements. The healthy convenience food operations, which include our Kettle Valley fruit bars operations and our Dakota Gourmet roast and snack operation snack operations performed as expected during the quarter. Our roasting operations are now operating near capacity.

Canadian Food distribution group revenues increased by $7.4 million in the second quarter, primarily as a result of acquisitions completed in 2004. Segment earnings in the second half declined in the second quarter declined by $809,000 to 612,000.

As reported in the last quarter, the group has encountered a number of issues over the last few quarters relating to supply, freight costs, competition, and integration. The supply issues related to weather in California earlier in the year improved during the quarter. However, competition in organic produce markets across Canada and the company's decision to aggressively defend its market share has resulted in deterioration in margins. We expect to continue to aggressively defend market share in the third quarter and into the fourth quarter. With the current high price of fuel, delivery costs have increased and this is expected to continue.

In early August, Kofman-Barenholtz was integrated into our new Toronto distribution facility. With the existing operations of Supreme Foods and Snapdragon, the transition went well and the 3 businesses are now operating out of one fully integrated state-of-the-art facility. As a result of the ongoing decline in results, the distribution group has implemented a significant profit improvement plan based on product offering and operational costs reductions.

These detailed plans expect to generate pretax profit improvements of up to 2.5 million Canadian on an annual basis and has been implemented with the resulting benefits expected late in the third and fourth quarters.

Opta Minerals group revenues increased by 9% in the second quarter, while earnings were essentially flat versus the prior year. In the first 6 months of the year, revenues and segment earnings have increased by 11% and 4% respectively.

During the second quarter, the 2 facilities in Baltimore, Maryland and Hardeeville, South Carolina began full operations and based on recently secured long-term contracts, will be operating near capacity for the foreseeable future. Also in the second quarter, Opta Minerals announced the acquisition of certain assets of Hillcrest Industries in Attica, and New York. This facility will process coal slice (ph) to serve the abrasives and roofing shingle markets in the northeastern US. The key to this acquisition was the long-term supply of a quality coal slotting source located in Rochester New York.

This facility has now been upgraded and has been commissioned. Based on anticipated new orders, this facility will also be operating near-capacity in the near future. The group is expected to experience strong growth going forward. The recent entry into the provision of abrasives for roofing shingles has added a new and important market for the group. Based on the combination of new housing starts and more importantly, the need to re-roof homes from prior housing booms, this market presents a great opportunity for the future of the group.

Opta Minerals will continue to pursue strategic growth opportunities in the coming months, both internally and through acquisition as we've indicated in the initial-- in the public offering completed in the first quarter. Jeremy has previously mentioned our new Steam Explosion contract with Abengoa. This is why we're very excited and bodes well for the future of this group.

Thank you, Steve. Although we're pleased with our revenue growth and strategic direction of our company, we are conscious of the need to improve our margins. We have implemented internal profit improvement plans right across the organization, with specific focus on our ingredients and distribution operations. We will also continue to evaluate acquisition opportunities that are strategic in nature and fit within our natural and organic vertically integrated model.

We continue to believe strongly in what we stand for and we are very excited about the future prospects of SunOpta. We'll now be very pleased to answer any questions that you may have. Please keep in mind that we may be limited in certain answers for confidentiality reasons.

Thank you.

(Operator Instructions)

We'll take our first question from Scott Van Winkle with Adams Harkness.

Hi, gentlemen. Congratulations on the Steam Explosion contract. It's been a long time waiting.

It sure has, Scott. And you know its just one of those that the great things of a dealing with a very, very large company is that the resources and the technology are there. But on the other side, particularly we're dealing in parts of an international company, so there are many, many levels of approval and translations of contracts from Spanish to English, and back and forth. So, it did take longer than we anticipated. But the goodwill on both sides was there and we are delighted that we could announce that contract yesterday.

Okay. So just to make sure that I was clear, this -- the contract you announced was for the European facilities?

Correct. And the second one, as we just mentioned here, it should be - we expect to be signed this quarter, is for the project in York, Nebraska. So, the European - in Europe, ethanol is primarily produced from wheat, in the US, primarily from corn. So our technology will be using wheat straw in Europe and using corn stalk or corn stover, as it's known, in the US.

Okay. Do you think that business is profitable next year?

Yes. Actually the Steam Explosion division has been profitable in the first 6 months. Unfortunately, what happens is that its results are integrated into the overall corporate cost structure, which includes the whole corporate staff, it includes audit and investor relations and all the various activities that are part of being a public company. So, its numbers sort of get lost. But it did contribute a small profit in the first half. In the second half, we obviously, with this new contract, we're hoping that it will contribute much more strongly.

Okay. Yes. I thought it was losing money, I apologize. Few questions. Steve mentioned that June was a very strong month over month, I think -- year- over-year, I think, the comment was for oat fiber. Does that mean it was up year-over- year?

No, Scott, my comment was that June was the strongest month we've had in fiber in 2005.

Okay. There is still showing decline.

It was down versus 2004.

But it's still down year- over-year?

Yes. But that gap is starting to close and I think we will see it on the comparatives in the second half.

Excellent. And that business started to fall off in October, was it?

Yes. That's when we -- yes, that's when it really started to. We started to see a little bit of weakness, but nothing major. But then in the last quarter it really fell off.

If you exclude oat fiber from your ingredients business, were profits up year-over-year?

Yes. I'm looking at -- yes. I think, yes.

Okay. So your major issue in ingredients to address, really is oat fiber.

Absolutely. Yes. I think we are making good progress there.

Okay. On the distribution side in Canada, it is -- this is the first time we have heard about the competitive pressures. You didn't still let -- you still hear a lot of companies talking about significant pressure is on California produce and you mentioned that you kind of worked through that. Is that because you're buying mostly organic?

No. I think the comment that I made was that it's certainly not like it was in the first quarter. I mean that was really, really bad in the first quarter and trickled through into April, but certainly not as bad as it had been.

We also, Scott, now into a lot of local projects in Canada. So in these next quarters, not the last quarter but in the third quarter and second quarter, we do get local produce to replace some of the imported products.

I know you like to compare yourselves to UNFI, which obviously a great comparison to make. They put through a price increase recently around 5%, I think it was $10 a stock. Have you put any price increases through for fuel?

Yes, we have. We have a fuel surcharge that we put in.

Okay. And on the facility in Toronto, is it to the utilization level where you expect to reap some benefits from putting those businesses together and the new state of the art facility?

Yes. You know Scott, we're just at the point or everything that was scheduled to be moved in is just in there now. And it's essentially full and we are closing -- you know we are closing the Kofman-Barenholtz facility at the end of November, that's when the lease expires. Well, yes, it's at that level now were there is significant economy to sale.

But then real benefit, Scott, I think, will not start committing in until the fourth quarter. I think that's kind of where we expect to see big improvement.

The good news is that the transition went well and we haven't had any -- we've learned from our prior moves.

And as Steve had said, we put in a cost reduction and business opportunity program, which we expect to generate an additional $2.5 million of savings. And that program is going very nicely. I think one of the really important things now is that, because we have established national distribution and really are the only national distributor in Canada. This is allowing us to secure numbers of new product lines on an exclusive basis in Canada because we can and are the only company that can offer this national distribution.

I might have missed it at the end there, but you talked about materials group. Did you talk about the EBITDA being down year-over-year and what was the reason there?

Sorry. You're talking about distribution group? I'm sorry.

The materials group.

The ingredients group.

Ingredients or Opta Minerals?

Opta Minerals.

I'm sorry. Okay. No, they are essentially flat for this year. They had an extremely strong second quarter last year when you're comparing it -- doing the comparison. The benefits of the new plant in Baltimore really just started to kick in at the end of the second quarter as that came on line. And then it is, as Steve said, essentially sold out for the rest of the year. The same can be said for Hardeeville in South Carolina, also essentially sold out. The new plant in Attica just started up this week, so we are expecting to get some really good contracts there.

We did experience, in the second quarter, some shortage of some of our high-priced abrasives, some of which we import from China and other places. Just a supply issue. And those have now been rectified, so we now have products. We sell, for example, we sell garnets (ph) for waterjet cutting for abrasives and for water filtration projects and we can sell every pound as soon as it gets on to our shelf. So, we did have some shortages there, as well. But we've got some increased supply now. So I think we're looking for a really, really strong second half in Opta Minerals.

Okay. And real quickly on the package, just a clarification. You talked about strength in Aseptic. I assume that is non-soymilk. You see a lot of soup businesses growing in aseptic. These single serve aseptic Am I correct, that's not really soymilk aseptic. It is everything else?

Soy milk is growing, but larger than that is rice.

Okay.

Rice is the big winner. We didn't mention, of course, also is that we run a number of private-label soymilk contracts for the -- on the refrigerated side. And so we've talked before about some of the ones that we won last year. And this year we've added Cub Stores and Albertson's, these haven't started yet in terms of production. But they have been secured, and a couple of others. So, we're seeing our private-label soymilk on the refrigerated side, that's where we of course produce the concentrate, growing nicely now.

And then, as Steve mentioned, we've got some significant new accounts coming on in soy powder, which then expands the soy concentrate business, because that's of course where the powder comes from. So we're really excited about the soy powder side. We have got contracts that we're working on in Japan and Korea and all over Europe. And this looks like a very good business for us.

Okay. And if we to step back and hold it, just so I can make sure I've got this right. I mean, this is the first quarter that you've had an operating profit decline year-over-year. Is it really a situation of the distribution business, competitive pressures being a new entry here? You're still tough on oat fiber. Everything we saw in Q1 plus the competitive pressures and distributions, is that really it?

That is really it. And we will expect to see, as we said, we'll have the third quarter and fourth quarter will both well exceed 100 million in revenue and we should see profit improvements in both quarters.

Great. Thank you.

You're welcome.

Our next question comes from Mark Chekanow with Sidoti.

Hi. When we look at the 4 components of the food group, as we have them broken out right now, can you just kind of go through, I guess, once all your savings plans are put through, I guess you get back to a normal EBIT levels. Can you kind of give us a rough idea as to what kind of EBIT margins each of those segments should be operating at?

I'll see, I have to -- I would have to take a little bit of time to get you that, Mark. Certainly, we will do that you for. I don't have that off chart (ph) with me right now.

We can say that, I think probably is that organic ingredients, which is the first part of our fruit group, essentially has doubled this business since we acquired that in last September. And it's operating margins are running in the sort of, as I say 14 to 18% range, that kind of thing. Then we have recently acquired of course Cleugh's. Cleugh's is the company that's running approximately $5 million plus a month in revenue, and we're just working through that on terms of margins. Pacific Fruit is a company that's running little over 20 million in revenues. Their margins, I think, run something around 25, 26%-- growth margins, I'm sorry, I'm talking about, right. So we put the group together, it is about $110 million and...

Okay. I would ask you then on the distribution side, when you look a year ago, you're kind of in that 7 or 8% on the EBIT margin side and this year you're kind of in that 2.5 range. Once everything is said and done then we'll tackle distribution, where do you see this business? Is it a 5% EBIT margin business, once everything is said and done?

Mark, I've got some numbers for you that I just pulled out of my file here. And I'm going to refer to segment earnings before other income.

Right.

I would say on ingredients side of the business we should see 12 to 15%.

Okay.

Packaged products 7 to 8%, Canadian distribution, 6 to 8%.

What about Grains and Soy products?

I just grab my file here. 6 to 8.

Great. Thank you.

Thanks a lot.

You're welcome.

Our next question comes from Chris Krueger with MJSK Investment Securities.

Hi. Good morning, guys.

Good morning, Chris.

Hi. I apologize if any of these questions have been answered. I missed about 2 minutes of the call. First, what was the depreciation and CapEx for the quarter?

Depreciation was -- do you have that?

Yes, 1680.

1.7.

1.7, okay.

CapEx was 3.

3 in CapEx.

3 million.

Yes.

Okay. If you look at the gross margins in the third quarter with kind of the profit enhancements things you've made as well as the acquisitions, would we look for that to be up a little bit from the second quarter?

Mark, you will see -- sorry, Chris, you will see improvements in each one of the groups. But with the fruit group coming on, inherently those margins are a little bit lower.

Okay.

Because of the high retail private label components. So we would expect gross margin improvements in all of the base businesses other than grains, which will stay fairly much where it is running at this stage of the game. And then, there will be a little bit of an offset created by the fruit group. Do you have the overall mix? I'm going to come back to your question.

Okay.

Chris, do have another question in the meantime while we are just checking that out?

Yes. The Steam Explosion, I think kind of remember on the last call you indicated that there is another potential customer beside Abengoa, a US-based ...

Yes.

...customer. Is that still on the works?

Yes. It is.

And do you think you will look for...

There is a lot of interest in a number of -- from a number of sources in US and Europe. As we said, ethanol is extremely topical today. We just finished the preliminary engineering actually on another potential project in the US.

Okay. All right. That's it. I'll just wait for the answer on the other question.

Overall on the mix just a slight improvement. Not real material.

Okay. Thanks.

Thanks.

We will now move on to Michael Glynn (ph) with RBC Capital Markets.

Thanks. Good morning, Jeremy and Steve.

Good morning, Michael.

Just on the consolidated gross margin, it was about 18%. So the idea is that we would anticipate that to remain roughly at those levels all through the back half of the year?

Yes, between 18 and 19.

What's the -- if business is increasing in the product mix.

And just in terms of the organic ingredients business, you mentioned that business doubled year-over-year. What kind of revenues does that business...

5, 7 million.

When we acquired it was doing about 12 and it's now running at 25.

Now it's running at 25?

Ballpark, yes.

And it's importing and purchasing organic ingredients from about 30 different countries now.

Okay. And the 2.5 million in cost reduction, is that -- that's coming entirely out of the Canadian distribution group?

That's correct. That's Canadian dollars.

That's Canadian dollars? Okay. Do have anything in terms of integration activities among the other sectors? Is there anything planned there?

Sure. Let me take you through that. In the grains and soy products group, the key integration activity right now is integrating Earthwise Processors into the operation. On our ingredient side of the business, the Cedar Rapids facility last year has been fully integrated, so there is still lots of work been done on the purchasing side. But as far as integrating systems et cetera, those are pretty much done.

On the distribution side, as I mentioned, we are in the process of completing the consolidation of the Toronto Warehouse, which has been ongoing. That's it for warehouse consolidation on that side of the business at this stage of the game.

On our fruit side of the business, there is clearly a large amount of integration going on that has been led by Sergio Varela and Michael Jacobs, Michael Cleugh, Joseph Stern as they integrate those businesses, integrate the reporting and the financial management. A great deal of work being done on the cost side of the business, which is very important. Examples being on the purchasing side, sugar, packaging, and sourcing from all over the world. Example, we just negotiated a new contract for workers compensation for that entire group that will save in excess of $500,000.

So there is some real opportunities for us. And if you asked about integration, there is ongoing integration in all of the groups, but there is a huge focus on realizing all the benefits that we can realize, as quickly as possible, from the integration of our fruit businesses.

On the minerals side, the Attica operation that we acquired, although it's just getting up and running now, has been integrated from a systems point of view onto the main platform that we have that run the minerals group so. Yes. There is lots of integration on going all of the time in this business.

Okay. And the increase in debt for quarter-over-quarter, that was primarily due to the acquisition?

Yes. That's correct.

Okay. And I'm just wondering, can you provide the operating cash after changes in working cap accounts?

Yes, the asset change in the working capital is 6.7 million for the 3 months.

6.7?

6.739.

Okay. Thanks a lot.

You're welcome.

Our next question comes from Russell Stanley with LOM.

Good morning. Just wondering if you can first of all give us some idea as to when the revenue will be recognized on the Steam Explosion contract?

Yes, we can do that. We do it on a percentage completion basis. And the way that the contract is setup is that we built 20% of the time of the contract so that's yesterday. And we then have progress payments throughout, resulting in 70 to 90% payment by the time the equipment arrives on site in Spain and 10% on start-up, but not later than 90 days after that. We're expecting to be shipping this equipment in January. So probably 75% would be built by the end of this year on the first contract. On the second contract, it will be somewhat less because we haven't actually finalized the details of that. But that will happen very shortly. So it will be setup in a very similar kind of fashion.

Okay. And on the other contract possibility for US customer, do you anticipate that being of a similar size?

It's going to be a bit larger.

And also as well, what sort of savings do you anticipate from the consolidation of the Canadian distribution operations at the Toronto facility?

Well, there are a number of savings. Clearly one of the savings is exiting one of the current leases that we have, duplicate warehouse, which is savings of over 500,000 Canadian. On top of that, there are a number of headcount savings that are generated overtime, which would be in the range of another $0.5 million. That's sort of culmination of the 3 coming together.

Great. And on the acquisition side, how much cash and unused debt do you see as being really available for additional pickups?

We have a pretty low debt to equity ratio, thus far, although, our operating lines are up. We still have cash available. But there is still room to do further acquisitions. We will be quite selective for the balance of the year. We need to digest what we built here and the timing was right to do that. But I don't see us doing anything significant for a period of time. We'll start to build up that cash basis again.

And I wondered, as well, I don't know if you touched on it earlier, but if you have the gross profit amounts by Food Group unit handy?

We don't at this stage. Do you have?

They will be in our Q. Q is out tonight.

Tonight. Okay. Great. Thank you.

You are welcome.

(Operator Instructions)

We'll move on to Michael Sproule with Octagon Capital.

Good morning, guys.

Hi, Mike.

Good morning.

Quick questions a bit all over the place. With regards to the Steam Explosion, coming into the year, you're starting to get all these contracts. Are you providing any sort of guidance or would you provide any sort of guidance for the remainder of this half on revenues and then going into '06, given your visibility on the contracts?

Specific to Steam, Mike?

Yes. Specifically, it sounds like it's going to start becoming much more material than it ever was. Everybody had a very small amount.

Somewhere probably between 4 and 6 million, depending on the timing of the contract on the second...

Yes

... second contract.

In '07, do you think this could be a double or triple?

Well, if those contracts were to aggregate, let's say, 15 million. Then they, just on both contracts specifically, you could obviously see the rest of it occurring next year.

Okay. Now gross margins on this product, I'm assuming some of it's going to be variable for a while. Where do you think you are going to fall basically on the average?

We're not going to disclose gross margins for competitive reasons. Like on that. But let's just say we're comfortable with what's happening here. Just for competitive reasons I think we also -- confidentiality with our customer.

All right. So, no range?

No.

Okay. Let's see what else we got here...

I think margins that you would expect on proprietary equipment of this nature, I mean that's rather general statement. But I think you could probably look at a number of different industries for guidance on that.

So, I mean, similar to what I would call a reactor, for example, the same sort of margins that a propiator (ph) reactor were to receive?

What type of reactor?

Typically a sort of chemical sort of reactor. Or any sort of...

Probably. Probably, yes.

All right. One of the things we were talking about with regards to the fruit side of the business. You mentioned your major player. Does that qualify you as like a number 2, number 3 player in the fruit side of things? Or how do you kind of stock yourselves up in the fruit side?

We are not aware of a lot of people with an integrated model like this, but you really have to break the fruit down, Michael, into what your main fruit is. And in our particular case, on the packaged side, the major part of our fruit would be strawberry. And the strawberry business, we would be in the number 2 position.

Okay.

Behind a big player like Dole probably.

Okay. But they're not necessarily organic at that point?

Right.

Okay. And then finally, with regards to inventory levels, inventory was up in the quarter. What is your explanation for that such as...

No, it really relates to the Cleugh's business. And the major driver there is the fact that the harvest takes place between April and July. So you come in, you finance it and then sell it out evenly over the balance of the year. We had how much in that inventory?

About 15...

So 15 million would be just due to Cleugh's. The bulk of the fresh product comes in and has to be frozen, and then we pack it out the entire year round -- all of the year round. But, fortunately, the product comes in all at once.

Okay. All right. Okay, guys. Thanks a lot.

Thank you.

Keith Howlett with Desjardins Securities has our next question.

Yes. I have a question on the segments. Will you be segmenting the Steam Explosion separately going forward, excluding the corporate overheads?

At this point, I don't think we're planning to do that, maybe for 2006. We'll have to see what the revenues look like. We have a lot of segments right now.

We're adding the fruit segment, as I mentioned, in the third quarter. So I think, probably, we will not segment out Steam Explosion; at least until 2006.

And just a question on the soy concentrate business. I think it's historically been put with the grain and soy products?

That's correct.

And is that true of all of the business that relates to the new private label programs for supermarkets?

First, there's been a packaged product keys, and then it shows up in packaged product.

Okay. Although you don't do the packaging for the...

We will manage the packaging.

Will manage the packaging? Okay. And the soy powder, which group does it show up in?

Soy powder will show up in soy...

Soy and grains.

Soy and grains? Okay. Great. And then just when you mentioned the 12 to 15% on the food ingredients business, was that with or without the fruit part of it?

That would be without fruit.

Without fruit. And fruit is going to be bit lower given the nature of the business?

Right.

Okay. And just on the organic fibers that you're doing. Are you using Steam Explosion for that or...?

In this particular case, we didn't use our steam technology. And the reason for that, Keith, is that we were able to utilize existing facilities that we already had in Cambridge to produce this product, so there was really no capital investment required in order to produce this line of fibers. We still are working on utilization of our steam technology. We have some very interesting applications. Quite frankly, this time last year I would have told you that based on the market demand, we'd have the Steam Explosion unit running by now. But with the market demand, we're in a building phase for volume and we have this technology kind of acculating.

Probably our first application of Steam Explosion in the fiber business will be in fibers that are beyond our current product line.

Keith Howlett Great. And is soy in your current product line or not?

We now have organic soy fiber.

Right.

And we don't, at this stage of the game, have a commodity soy fiber, if you will. But that's certainly something that we're always looking at.

And just a question on the Steam Explosion. Is there -- Brazil is a big ethanol producer with sugarcane. Is there any application to your technology with the sugarcane, ethanol or do not need it for the production of...?

You're right, Brazil is using sugar to ferment ethanol and I think average is about 25% in fuel but up to 100% in certain cars. The application for Steam Explosion would be in the processing of the gas, which is the residue. So after you've squeezed out the sugar out of the cane, what's left is called the gas. So that is a product which can be steam exploded and the sugar is then recovered to convert to ethanol. So that may well be a further market for us.

Thanks. And then just, finally, just to double check, there is no change in the outlook for the relationship with Dean Foods and White Wave?

No. We have a take or pay contract with White Wave, which finishes at the end of this year. They are continuing to buy product from us and so whether they will continue to buy products after the contract is over, I suspect they will. But I don't expect it to be that significant because they have put a lot of their own facilities in. On the other hand, as we mentioned earlier, the growth of our soy powder business is such that I expect that probably by the end of this year the soy -- the new soy powder accounts will have taken up all of the soy concentrate that was going to White Wave. So no loss of business there.

Great. And, just one last question on the capital structure. What sort of debt equity level would be the maximum that you would...

Probably 0.721.

Yes.

0.721.Great. Thanks very much.

(Operator Instructions)

We'll move on to Derrick Chapel (ph) with Everest Capital.

Good morning, gentlemen.

Good morning.

I just wanted to ask in reference to how much buyback you guys have left?

Oh, my gosh. I think that really -- We have purchased $150,000 worth of stock back in...

Right after we ....

...right after we announced that in April. And that is it. So a total of how many shares? About 33,000 shares, a very, very small amount. The purpose of our stock repurchase plan was to attempt to stabilize the price at that time. And of course, the price has been recovered somewhat from that level. It was never a project that I personally -- I would much rather use our available funds to grow the business than to buyback stock. And -- but it was important that we take a position and we did. And I will continue to do that if we need to. But -- so we really didn't spend very much money on it.

Okay. On reference to receivables, are you guys working on trying to improve that?

Any comment on receivables?

Our receivables -- our DSOs, they are in line with where they normally are. We don't see any issues. They have grown because of the acquisitions that we've done.

Yes.

Okay. All right. Thank you very much.

You're welcome.

Keith Howlett with Desjardins Securities has a follow-up question.

Yes. I just had a question on the Canadian distribution business. The mention of the competition, is there a new entrant in the market or is it an existing player that is seeking market share?

Keith, we've had new entrants in the market and they come and go. And there are new entrants in the western Canada markets. There have been new players into the markets now for a number of months and we're dealing with that. And the rest of the new entrants in the central Canadian market as well that are relative -- a bit new, if you will, than on the western Canadian side. But...

These entrants are primarily in produce, just to be clear. They are not in organic groceries, which is a significant part of our business. In fact, our grocery business is doing very well.

There is nobody major like a UNFI or something?

No, they're very small companies. And we obviously have a far, far wider product range to offer to people. So we're trying to compete on service and quality and diversification of product.

Great. Thank you.

(Operator Instructions)

Okay. Well then...

There are no further questions at this time, Mr. Kendall.

Okay. Thank you very much. Again, I'd like to thank everybody for listening in and to invite you to call us if you have any further questions. And we look forward to talking to you. Thank you. Bye-bye.

And that concludes today's conference call. We thank you for your participation and have a nice day.