Sunopta Inc (STKL) 2012 Q2 法說會逐字稿

Good morning, ladies and gentlemen, and welcome to the SunOpta Inc. second quarter 2012 earnings call. Before I turn the call over to Steve Bromley, CEO of SunOpta Inc., we would like to remind listeners that certain information discussed today may include forward-looking statements and therefore are subject to important risks and uncertainties. Actual results could differ materially from the conclusions, forecasts, and projections discussed today as certain material factors and assumptions were applied in drawing conclusions and in the making of forecasts or projections upon which the forward-looking statements are promised Additional information about these material factors and assumptions, as well as other risks, uncertainties, and-or revelant factors, are set forth under the forward-looking statements and risk factors in the Company's annual report on Form 10-K in the fiscal year ended December 31, 2011.

We would also like to remind listeners that the Company may refer to certain non-GAAP financial measures during this teleconference. A reconciliation of these non-GAAP financial measures was included with the Company's press release issued last night. A copy of the press release is available on the Company's website at www.SunOpta.com. I would now like to turn the conference over to Steve Bromley.

Thank you very much, and good morning, everyone. Welcome to our 2012 second quarter shareholder conference call. I'm joined on the call today by Rik Jacobs, our new President and Chief Operating Officer, Rob McKeracher, our Vice President and Chief Financial Officer, and John Ruelle, our Vice President and Chief Administrative Officer. Before we get going, I want to mention that we filed Form 10-Q for the second quarter yesterday.

Before we discuss our record results for the second quarter, I am pleased to introduce Rik Jacobs, our new President and Chief Operating Officer. Rik joined us a little over a week ago and has assumed operating responsibility for our core natural and organic foods business. Rik brings over 20 years of international sales, marketing, innovation, strategic development, and general management experience to this role. Over the past 11 years, he held a number of progressively responsible positions with Tetra Pak, the world's leading supplier of equipment and materials for the processing and packaging of liquid food products and a key supplier to SunOpta. Most recently, Rik served as Cluster Vice President for North Europe with responsibility for the UK, Ireland, Scandinavia, and the Baltic states. Prior to this, he served with Tetra Pak in a number of different senior leadership roles including Vice President of Strategy and Planning and as Vice President of Sales for Tetra Pak USA.

Prior to Tetra Pak, Rik held a number of international sales, marketing, and general management positions with PepsiCo, Royal Dutch Ahold, and the Coca-Cola Company. We are really excited to welcome Rik to SunOpta. His extensive international, commercial, and industry experience will be extremely valuable as we expand our commercial development and innovation priorities and position the business for continued growth and improving profitability. Rik will bring a new perspective to these initiatives and play a key role as we continue to build a global leader in natural and organic foods, categories we believe offer excellent long-term growth potential. With that, let me introduce you to Rik Jacobs.

Thanks very much, Steve, and good morning, everyone. It is a pleasure to have the opportunity to introduce myself and while my comments will be brief today, I do look forward to meeting many of you in the future. SunOpta has built a global presence in natural and organic foods, and I am really looking forward to working with the team to not only continue the growth, but in fact, accelerate the Company's development in this space. The Company's integrated capabilities are unique and form a solid base within which to growth, and that is what makes me excited to join this Company. Once again, I look forward to meeting many of you in the coming weeks and months. And, with that, I will turn the call back over to Steve.

Thanks very much, Rik. Great to have you on the team, and we look forward to an exciting future. We know that the drought conditions in North America are on many people's minds. There is no doubt that the lack of rain and extreme heat in many regions will have an impact on the crop this year. Having said that, we are fortunate that many of our key growing regions have not suffered to the extent of others, and as a result, we expect to have fair to average quality crop. On top of that, because we have built up a diverse global supply chain over the years, we are confident that we will be able to meet the growing demand of our value-added consumer packaged goods and ingredient customers.

Let's now turn our attention to the second quarter. We are very pleased with our results. Rob will get into the specifics of the financials in a moment. But in summary, we had a strong quarter, and we continue to realize the benefits of initiatives which we are implementing. In fact, earnings for the second quarter were a record for the Company after excluding one-time items that were realized in certain prior years. And, when combined with record earnings in the first quarter, our first half results are also a record for our Company. In addition, our cash flow from operations for the first six months was also a record for our Company.

In the second quarter, we realized revenues of $282.3 million reflecting internal growth of 5%. But more importantly, our segmented operating income increased 46.7% to 5.1% of revenues versus the prior year at 3.6% of revenues. It is important to note that our top line excludes Purity Life for the entire quarter and reflects the impact of rationalization of a number of unprofitable products as well as the devaluation of the euro. For the quarter, we realized net income of $8.1 million, or $0.12 per diluted common share, versus $4.4 million, or $0.07 per diluted common share in the prior year. The results include a number of one-time costs and benefits that essentially offset each other. These results reflect our continued efforts to improve operating margins, and while we still have a ways to go, we are pleased with our progress to this point.

During the second quarter, we realized very strong cash flow, generating $28.8 million in cash from operating activities in addition to the proceeds from the sale of Purity Life Health Products. As a result, we significantly reduced debt outstanding to $159.1 million at the end of the quarter, down $37.1 million versus the first quarter. When combined with the recent amendment and expansion of our syndicated credit facilities, we are well positioned with the resources to support both internal growth projects and future potential acquisitions. On July 30, we announced that we had entered into an amended and restated credit agreement with a syndicate of lenders providing borrowing capacity of $175 million for our North American operations as well as an accordion of a further $50 million to support our future growth objectives. Borrowing costs will also be reduced under this new facility. We're really pleased to have completed this financing, and as always, appreciative of the continued support of our lenders. I also want to note that we currently have approximately $70 million of incremental availability to fund future growth, and on top of that, of course, we would have the accordion feature if we so choose to use that.

During the quarter, we completed the sale Purity Life Natural Health Products for CAD14 million plus a CAD700,000 note which is contingent on future EBITDA targets. In June of 2010, we divested of our Canadian food distribution assets, and the divestiture of Purity Life completes our exit from the Canadian food and natural health products distribution business. These transactions further simplify and streamline our business while strengthening our balance sheet and allowing us to continue to focus on our core natural and organic product offerings.

During the first quarter of 2012, we commenced the process to streamline our operations in organizational structure, addressing underperforming food-based operations, targeting improved earnings, predictability, and Return on Assets. In doing so, we realigned our operating segments, rationalized a number of operations and staff functions, and addressed certain underperforming business operations. This process continues, and the benefits are now becoming evident in our financial returns. In summary, the record results of the second quarter and first half are very encouraging, and we believe we are well positioned for long-term growth in exciting natural and organic foods categories.

With that, I will now pass the call over to Rob to provide further specifics on our financial results.

Thanks, Steve. Good morning, everyone. I will take the next few minutes to review our financial results for the second quarter ended June 30, 2012. Please note, all figures discussed today are in US dollars unless otherwise noted. For the second quarter of 2012, we reported revenues of $282.3 million as compared to revenues of $275.2 million during the second quarter of 2011, a year-over-year increase of 2.6%. Excluding the impact of changes including acquisitions, foreign exchange, commodity pricing, and rationalized product lines, our consolidated base growth rate was approximately 5%. Second quarter revenue growth reflects continued momentum in the integrated packaged food product categories within SunOpta Foods. Offsetting this growth was the effect of product rationalizations in SunOpta Foods, and in addition, we experienced volume declines in certain food ingredient categories and at our European sourcing and supply operations due mainly to the ongoing economic uncertainty in the region.

Operating income for the second quarter of 2012 increased to $14.3 million, or 5.1% of revenues, versus $9.8 million, or 3.6% of revenues in the prior year, a 46% increase compared to the second quarter of 2011. This increase was driven by improved operating income in SunOpta Foods, primarily from the Grains and Foods Group. Continued growth in aseptically packaged beverages includes improved sunflower pricing and stronger margins in the food ingredient categories contributed to the increased profitability. It is worthy of mention that overall, our consumer packaged food category has experienced approximately 14% revenue growth compared to the second quarter of 2011.

During the second quarter, we reported earnings of $8.1 million, or $0.12 per diluted common share, as compared to earnings of $4.4 million, or $0.07 per diluted common share during the second quarter of 2011. Earnings from continuing operations for the second quarter of 2012 were $7.6 million, or $0.11 per diluted common share, versus $5.6 million, or $0.08 per diluted common share in the prior year. Included in earnings for the second quarter of 2012 was approximately $1.7 million in pretax severance, acquisition, and start-up costs which are somewhat offset by approximately $655,000 in tax adjustments that lowered the Company's effective tax rate during the quarter as well as a gain on the sale of Purity Life Health Products of $676,000. Earnings for the second quarter of 2011 included pretax gains on the sale of assets of $3 million and a favorable adjustment on a legal claim of $500,000.

On a year-to-date basis, we reported revenues of $541.6 million versus revenues of $520.5 million last year, a year-over-year increase of 4.1%. Excluding the impact of changes including acquisitions, foreign exchange, commodity pricing, and rationalized product lines, the consolidated base growth rate for the Company was approximately 6%. Year-to-date, we have realized earnings of $14 million, or $0.21 per diluted common share, as compared to $9.5 million, or $0.14 per diluted common share last year. A 50% increase on a per share basis. Year-to-date, we have realized EBITDA of $36.9 million as compared to $30.4 million last year, a 21% increase year-over-year.

At June 30, 2012, our balance sheet reflects a current ratio of 1.47 to one, and a total debt to equity of 0.51 to one. Total debt outstanding at the end of the second quarter was $159.1 million, a decrease of $37.1 million from March 31, 2012. To end the second quarter of 2012, we had total assets of $643.5 million and a net book value of $4.75 per outstanding common share. The reduction in total debt versus the first quarter was primarily due to cash provided by operating activities of $28.8 million, as well as a $13.4 million in cash proceeds generated from the sale of Purity Life. On a year-to-date basis, we have generated cash from operations of $21.5 million, a record for the Company, as compared to cash used in operations of $13.4 million during the same period in 2011.

Capital expenditures of $7 million in the second quarter and $11.9 million year-to-date include spending at our aseptic soy milk and alternative beverage facilities plus investment in maintenance spending across a number of other business units. Cash used in financing activities of $33.9 million during the second quarter reflects the application of our strong operating cash flows and the proceeds from the sale of Purity Life against our line of credit facilities. On a year-to-date basis, cash used in financing activities is $2.8 million, reflecting the $17.5 million acquisition of Babco by Opta Minerals and cash used to fund working capital during the first quarter which offset the strong second quarter cash flows.

On July 27, 2012, we amended and expanded the credit facilities that are used to finance our core North American food operations via a new four-year agreement with a syndicate of lenders. The amended agreement provides for additional [boring] capacity and includes a $175 million committed revolving facility as well as an uncommitted $50 million accordion feature. The new facility replaces our existing term and revolving facilities, which at June 30, provided approximately $146 million of committed funds. The new facility will lower our overall boring costs and when combined with positive cash was operations, will provide increased financial flexibility and capital resources to support both internal growth projects and future acquisitions.

At June 30, 2012, the Company's outstanding debt was comprised of three primary debt facilities. A $51.7 million in facilities which support our North American food operations, $56.7 million for a facility that supports the International Foods Group, and $47.1 million in facilities at our non-core subsidiary, Opta Minerals. All three of these facilities are standalone and support the operating groups just mentioned with no recourse or cross-default provisions between them. The increased boring capacity provided by the new credit agreements, improved operating margins, cash flows, and a strong balance sheet continue to keep the Company well positioned for future growth and provide added flexibility when assessing strategic expansion options. With that, I will now turn the call back over to Steve.

Rob, thanks very much. As previously mentioned, our operating earnings increased to 5.1% of revenues during the quarter. This increase was led by strong results from the Grains and Foods Group, which realized revenues in the second quarter of $136 million versus $125.1 million in the prior year, and realized segmented operating earnings of $10.5 million, or 7.7% of revenues. Our operating margin target for this group is 6% to 8%. So, needless to say, we are very pleased with this performance. These results were driven by continued strength in the Groups' value added packaged products, especially non-dairy aseptic beverages plus strong margins on organic grains and feed and much improved results in the Group's sunflower operations versus the prior year as we are now serving European bakery kernel customers from Eastern Europe's supply versus more expensive North American supply sources.

We continue to reinvest in our grains and foods operations, and our project to expand processing capacity at our Modesto, California aseptic processing facility is on schedule for completion late in the third quarter. In addition, we are making investments to expand our grains roasting and packaging operations and add capabilities to expand our grains-based ingredient offerings. As discussed previously, our Ingredients Group has faced increased competitive pressure, and while the results for the Group are below the record results achieved in 2010, we remain optimistic in the Group's future prospects. Revenues for the Ingredients Group during the second quarter were $20.5 million as compared to revenue of $23.7 million last year, reflecting softer demand from our existing customer base. Associated with the sales decline, production volumes in our plants were also lower, which contributed to lower than targeted operating margins of 4.1%, or approximately $800,000 during the quarter. An approximate $800,000 decrease in operating income compared to 2011.

While these results are below target, we remain confident in the prospects for the Ingredients Group as there are a number of significant opportunities in the pipeline. Many of these initiatives require significant resources from both ourselves and our customers, and the timing to bring a number of these opportunities to fruition has been significant. We have also continued to streamline our ingredients operations in an effort to reduce costs and increase efficiencies and should continue to see the benefit of these rationalization efforts as we move forward.

During the second quarter, we launched three new food ingredients. First, a new proprietary rice fiber which can be used in gluten-free applications. We launched cellulose fiber which further broadens our portfolio of fiber offerings. And thirdly, we launched a new generation starch product which can be used in a variety of dairy products, in particular, for use in the fast-growing Greek yogurt category. Also during the quarter, we commissioned our new aseptic line in our fruit ingredient operation and commenced commercial production. The new line has the ability to contribute incremental value-added revenue in excess of $20 million.

The Consumer Products Group returned to profitability in the quarter, albeit marginally, and if not for start-up and other business integration costs, would have realized significantly increased operating income compared to the second quarter of 2011. Operating income in the Consumer Products Group was negatively impacted by start-up costs related to our resealable pouch expansion initiatives in the Eastern US, the transition of the San Bernardino juice operations, and the expansion of our production capabilities at our Carson City snack bar facility. We are confident that the expenditures on these initiatives will result in positive contribution in the future.

As expected, the frozen fruit operations were profitable in the second quarter and significantly improved versus last year. In addition to improved profits, inventory levels have also been substantially reduced, as planned. The healthy snacks operations continued to report sales growth for its fruit, protein, and baked bar product offerings, and we are considering further expansion as the demand for fruit-based, healthy snack alternatives continues to grow. We're also in the early stages of a number of upgrades to the group's protein and baked bar operations located in Carson City, Nevada, which are designed to improve efficiencies and expand capabilities at that operation. We remain confident in the prospects for our healthy snacks business and continue to believe that portable, nutritious, natural and organic food is a key platform for growth.

The food solutions operations, which are also part of the consumer products group, delivered increased revenues in the quarter, but results were impacted by costs related to the juice extraction and packaging facility located in San Bernardino, California, as well as start-up costs related to our new pouch-filling operation located in Allentown, Pennsylvania. The project to sell a wide range of products in flexible, resealable pouches continues to develop positively. We now have two lines operating from a production facility in California and have commenced commissioning of two further lines at our new facility in Allentown, Pennsylvania. In fact, we have been visiting the Allentown facility for the last few days and are making this call from the facility today.

The facility is expected to be fully commissioned later this month. And with that, we will then have annual capacity of approximately 100 million pouches with the bulk of the capacity now committed and numerous opportunities for further growth. We're very pleased with this initiative, and we believe we're well on the way to creating a profitable, integrated platform which we expect will generate $100 million in profitable revenues over the next couple of years.

The International Goods Group, which following the sale of Purity Life now comprises our organic ingredient sourcing and supply platform, continued to perform within its target operating margin range of 5% to 6% realizing operating margins of 5.6% in the quarter. In the second quarter, the International Foods Group reported revenues of $45.5 million and operating income of $2.5 million as compared to revenues of $53.9 million and operating income of $2.9 million last year. The weakening of the euro relative to the US dollar caused the Group's revenue in 2012 to be lower after translation. This foreign exchange effect explains approximately two-thirds of the revenue decline. The remainder of the decline in revenue is due to lower sales of organic orange juice -- primarily organic orange juice and organic coffee, mainly in the European arm of the operation.

The US operations continue to see year-over-year growth, mostly from organic ingredients including supply to a number of our value-added, consumer-packaged goods customers. There is a sense of some slowdown and demand in the EU markets, but the outlook in North America continues to be strong so we expect results to remain solid going forward, recognizing the record results achieved over the last couple of years in this business. The Group continues to develop new product offerings and new global sources of supply, and we're actively pursuing opportunities to expand the Group's processing activities, similar to the integrated model we have in North America.

Late last year, we announced that the Board of Directors of Opta Minerals had decided to suspend its strategic review process for the business. The decision to suspend the process was based in part on an assessment of global market conditions, but more importantly, the number of actionable, near-term growth opportunities within Opta Minerals which in our opinion once completed would make the Company more attractive to potential acquirers. As part of these growth opportunities, Opta acquired Inland Refractory and Babco Industrial Corp. Recently, Opta has offered to acquire all the outstanding shares of WGI Heavy Minerals.

WGI sources processes and markets, industrial abrasive minerals, primarily garnet, and also source, assemble, and sell ultra-high pressure water jet cutting machine replacement parts and components. In its most recent fiscal year, WGI realized revenues of CAD37.8 million. The product portfolio and global geographic reach of the WGI business is expected to be a good fit with Opta and is also expected to generate efficiencies and synergies as the capabilities of the organizations are leveraged. The offer to purchase expires on August 29, assuming of course that a competitive bid is not received by WGI before then.

For the second quarter, Opta Minerals realized strong revenues, but operating income declined to $1.8 million versus $2.2 million due to the bankruptcy of a steel customer that required a bad debt allowance of $945,000. Excluding this cost, operating earnings would have increased approximately 25%. Opta Minerals is well run with a strong management team and operating systems thus allowing the senior management of SunOpta to focus on our core natural and organic foods business. Opta Minerals remains non-core for SunOpta, and our intention remains to divest of this business and maximize the value for our shareholders.

In conclusion, our goals for this year and beyond remain focused on building a profitable, sustainable, and growth-oriented, global natural and organics foods business including -- improving our profitability in support of our objectives of 8% operating margins, 10% EBITDA margins, and 15% Return on Assets. Two, leveraging the strengths of our organization to drive our position in natural and organic foods categories that we believe are very relevant in today's society and offer excellent opportunities. Three, investing in our core value-added, natural and organic foods platform by internal growth projects and strategic acquisitions. And finally, four, continuing to explore potential divestitures of non-core assets.

We are very pleased with our record second quarter and year-to-date results, and we remain committed to building a profitable, sustainable, and growth-oriented natural and organic foods business. We are confident in our future prospects and look forward to a successful 2012 and beyond. With that, we will now open the call to questions.

(Operator Instructions)

Greg Badishkanian, Citi.

Hi. Good morning. It's actually Alvin Concepcion in for Greg this morning. Just wanted to follow-up on some comments you made. You mentioned consumer demand in North America held up pretty well, but you saw some slowdown in the EU markets in the quarter. Did you see any changes in demand in July and August to-date relative to June in North America?

I would say the North American business has stayed very consistent.

And what about in Europe? Did you see a further slowdown, or did it stabilize?

I wouldn't say we have seen -- I can tell you for sure we didn't see an uptick. And it is probably flat, at best. The European economy is struggling through, and actually we've had great conversations the last few days with Rik who has just come from Europe. It's flat right now. Yes, it's not growing, that's for sure. Our forecasts are that that's not going to change over the course of this year.

Okay, fair enough. Just wanted to get your view on overall commodities inflation for the rest of the year and 2013? You've typically been able to pass on the pricing. Do you believe you'll be able to fully pass on pricing this round? And how much of a lag in timing would you expect in passing on those prices?

Alvin, I am going to let John Ruelle, who is our Chief Administrative Officer, who, previous to accepting this role was the Chief Financial Officer in the Grains and Foods Group, and has in-depth knowledge of the whole commodity complex and how that is going to play out -- jump in and answer that. John?

At the end of the day, we think where the markets are right now, we are starting to see some demand-side corrections where ethanol companies are maybe backing off a little bit. So, we're not expecting huge continued run-up. And as far as the pricing, we do have provisions in all of our value-added consumer product offering agreements that provide us the opportunity to pass those costs through. And timing is such that we should be able to get that done about the time that new crop is being harvested and flowing through inventories.

Great, and then just one last one. Your operating margins expanded in the quarter year-over-year pretty nicely. Would you expect that expansion to accelerate further in the second half of the year, given, I believe a lot of your cost savings are going to be more pronounced in the back half of the year?

Over time, our objective is to move to 8% operating margins, and we don't really look at the operating margins quarter-to-quarter because there are seasonality impacts in the business and product mix issues in the business. But clearly, we are all focused on moving to the 8%. We're going to do that, and that is happening. So, we're very confident in our ability to execute that over a period of time here.

Great. Thank you very much.

Thanks a lot.

Thank you. Christine Healy, Scotiabank.

Thanks. Congratulations on the good quarter. I wanted to start out on the US drought. Just wanted to confirm all the comments that have been said. Because I think this has been a concern of investors lately. Just to confirm it, Steve, it sounds like overall you don't expect it to have a material impact on your earnings in 2013? Is that safe to say? You're going to have enough supply for processing. Quality should be fair to average, and pricing increases -- you should be able to pass those through? Is that what we can take away from that?

Christine, a couple of things. The pricing comment is right. At this stage of the game, fair to average crop is correct. Now, mid-July to the end of August are core, key times for the development of soybeans. At this stage of the game, we think that is right. We're really fortunate. We're getting a lot of timely rain in a lot of places, which leaves us more encouraged than not.

And as we mentioned, and for those that are probably aware, our growing regions are primarily North versus South. Not that we don't have some southern growing regions because we spread ourself out, but one of the reasons we spread ourself out is for exactly what is happening. If you had all your crop sitting in the South of the US, you are in deep trouble. So, we spread ourself out. But just because of the crops that we handle, we are more into the northern states, and we are more into Canada. And that all gets supported by a global structure.

At this stage of the game, we're really confident that our consumer-packaged supply -- the supply for our consumer-packaged and ingredients business, which is where the margins really are -- we are in good shape there. And if there's going to be some shortfall, it would be on a lot of the lower commodity value -- not the value-added materials that we process if we're going to be short. But we have a global system, and I can tell you that our people are hard at work sourcing and developing supply from other regions.

We think there's probably going to be some shortage, but it's in the low margin products that we handle, if it can't be fully compensated by our international sourcing effort. But it's really dependent on what happens here over the next period of time. That's where we sit today. With the type of rains we're getting, I don't think it's getting worse for us.

Okay. And then, just looking at your segmented sales, it looks like your food sales growth in Canada is far outpacing that of the US, up 20% year-to-date. Can you talk about the Canadian market? Some of the drivers for the huge growth there?

Sorry, Christine. This is Rob. You're taking that, I guess, out of the Q. The big growth that we have seen is -- I think we touched on it in the call -- is more so in North America. And I would have to get back to you on the split between with Canada and the US, but -- .

I think US is only up 6% year-to-date versus last year first half, and Canada is up 20%. So, it's huge out-performance. I was just wondering if there was a couple things that you could point to for that?

That's one I would probably have to get back to you on. We had focused a little more on North American versus European. I can get back to you on that at a later date.

Sure. Last question on Opta Minerals. Steve, you were talking in your comments that you guys had a strategic review on what to do with your interest, and hoping to get an update on that. I'm sure you guys saw the news earlier this week from Dean Foods spinning off its organic food division. Market sent the shares up over 40%. So, it's clear investors put a large premium on a national and organic food pure play. Is this something the Board of SunOpta is committed to? Still looking to become a pure play food Company? Can you discuss that, and the potential timing?

Sure, absolutely. Yes, we do. The transaction that Dean Foods executed certainly didn't fall on deaf eyes and ears here, and I think we have been really clear, and I can confirm for you that our Board is committed that Opta Minerals is a non-core business. Our intention is to divest of it. We went through the process last year. A combination of market conditions and future opportunities, combined with -- our balance sheet is really solid. And there wasn't a need for cash at the time.

We felt that, look, giving the business a period of time to complete acquisitions and internal growth projects that they had on the table would make some sense. And that the potential increase in shareholder value that we created, we would create in that shorter-term period -- short term being, say, a year, 18 months, was worthwhile for SunOpta. But as I said in my comments, Christine, we remain committed to becoming a pure play food company, and I would be reticent just to put a day on it. But we remain committed to do that.

Okay, and some investors I've heard are concerned on whether or not there would be interest in Opta Minerals? And when you canceled the strategic review, was that because there wasn't an interest for that? Are you confident that there would be interested buyers in this segment? You do have larger --?

I'm confident there are, unless all of those who were interested before have gone away, and they haven't. We clearly believe that there will be good interest, and would suggest that there may be increased interest given the size and scale of the business versus what it was prior. That's all to be proven, but certainly there will be interest in that business.

Great, thanks so much for your comments.

Christine, it's not just interest from strategics. This is a nice, strong, steady, stable cash-flowing business. Look, they had a very unfortunate situation last quarter when a big customer went into Chapter 11, and they wrote off the entire bad debt. They will get a certain amount of that back. They just don't know. So obviously, you write it all off. But other than that, this business has been growing and doing well, and profits have been doing well excluding that bad debt. There's no reason to think that it won't continue. So, it has a number of interested potential purchasers.

Great, thanks so much for your comments, Steve.

You've probably jinxed me now. (laughter) It will be good. Thanks, Christine.

Thanks.

Tim Tiberio, Miller Tabak.

Good morning. Congratulations on the great quarter. Steve, you mentioned that you are still progressing towards this 8% target. From roughly the 5% operating margin level that you are at currently, excluding any obviously seasonal fluctuations, what does SunOpta need to do on both a cost and a growth side of the business over the next 9 to 12 months to make that next step towards that level?

There's really a number of core components, Tim, that take us the rest of the way. First, there is continued cost reduction and cost leverage. We now have a platform in place that, as we grow, we are not in a position where we are adding a bunch of admin resources behind. We get the benefit of growth as we move on a platform that is being stabilized and rationalized. So, we continue to work on that.

Second is product mix. We have talked many, many -- we talk a lot internally, and Rob mentioned that our consumer-packaged products are up 14% in the quarter. Our margins increase exponentially as we add value to products. And so, our focus is on value-added ingredients in consumer products where we are adding value, but utilizing the supply that we have to do that. And so, we're very fortunate in that we've got supply, and we have global supply that we can leverage in the finished packaged products that will help drive that. That's a very, very important part of our strategy.

And then thirdly, it's bringing new products to the market. New, innovative products that do innovative things for the natural and organic foods industry that aren't under forms of market pressure. So, things like sunflower milks, our pouch-filling -- our aseptic -- our long-life pouch-filling opportunities, leveraging our integrated capabilities. We got into the pouch business because similar to our aseptic beverage business, we control the raw materials. So, rather than just sell the raw materials at a lower margin, get the raw materials into a value-added package and increase the margin. So, that sort of effort. And then, rice fibers and specialty starches and new ingredients across-the-board. It's really a combination of the three. That, in summary, if you took the business units and how they are going to roll to there -- those are the key themes.

Okay. On the product mix side, it sounds like the pouch-filling capacity expansion is probably the top opportunity. You mentioned that your capacity will be at 100 million pouches, if I heard correctly? What is your current utilization? Is this an opportunity as you ramp that to get better fixed cost absorption through these facilities?

For sure. The facility in Allentown, Pennsylvania that I'm looking out the window and watching commission itself right now -- not commission itself, being commissioned -- has two filling lines in here. But similar to how we built our Modesto facility, there is lots of room here for more. And our intention is that this will not be a two-line facility for long. Once the lines are up and running, over 80% of it is committed already. That continues to grow.

It's not just here. We are expanding our Modesto, California aseptic packaging facilities, putting another processor in there to continue to serve increased demand. We talked about Pacific Fruit processors where we just added an additional aseptic filling line to meet demand for fruit -- organic and natural fruits in food products. More and more fruits going into products because of the fiber content that's in the fruit and all of those sort of things -- the health benefits. A lot of areas on the value-added side that we are looking to grow. You're quite right. The pouch opportunity for purees and sauces and beverages is really unique, and it really plays into portable, easy nutrition.

Thanks. Just one last question. There's been a lot of focus, obviously, on the commodity cost pressures in the market, but does this also give you an opportunity over the next few quarters within the feed business? What is the opportunity there?

Sorry, Tim, in the feed business?

Yes, as far as within your overall grain and sourcing, is there opportunities outside of in-sourcing for some of your value-added products to take advantage of rising feed costs?

Yes, certainly -- this is John Ruelle. Certainly, sitting where we are right now as the commodities are running up, we're in nice cost ownership positions in a lot of the inventories that we have right now. So, we are experiencing very strong margins on our feed business. As Steve mentioned earlier, our global sourcing platform is what gives us confidence that if there is a fair to average crop, and we have to divert more of what we get in on an annual basis to our value-added, consumer-packaged goods and ingredients segments, that is where we augment that with our international supply, which would primarily support our feed and lower margin commodity businesses. I think the answer is yes, and certainly here as we work through the current-year crop with the increased pricing, there will be spot sales opportunities at healthy margins.

Great, thanks for your time.

Take care, Tim. Thanks.

[Ron Reuven] from [Reuven] Capital.

Hi, how are you? Impressive quarter. Couple of clarification questions. In regards to the derivative -- unrealized loss of derivatives, was that a hedging instrument for one of your -- one of the things you did? Or can you give me some color on that?

This is Rob. Are you picking this up, Ron, from the cash flow statement, or --?

Yes, the operating activities. There is $1.2 million in unrealized loss on derivative instruments. And on the two quarters, it shows unrealized loss of almost $1.9 million.

That essentially relates to primarily any derivative instruments that we are using to hedge our positions from a price perspective on commodities. It could be soy, corn, cocoa. What you're seeing there is the non-cash impact -- so, what is missing is the cash impact. As a general rule, we are fairly well covered. In the cash flow statement, what is missing is the fact that in order to -- the way these things flow because we're starting with the P&L and net earnings, it's only presenting the non-cash impact. So, there would be a cash benefit that isn't being presented there. It's not -- I wouldn't look at that as a big loss or gain that is impacting us one way or another during the quarter. If it was, it would come out in our commentary and show on the actual income statement.

That was pretty much what I was trying to get at. The almost $7 million property and the property purchase -- or property and equipment purchase? Is that the same thing you were mentioning that you were -- the same property you mentioned in the call that you were planning on making about $100 million in the next couple of years on?

Some of the spending would be in there, and it's the other things that we talked about -- the new processor in Modesto, and general spending to maintain our facilities and operations. But some of that spending is in there, for sure.

Okay. One main question. It looks like the gross profit relative to the growth -- the growth in gross profit being 16% relative to 2.5% growth in revenues is significantly more than what I have seen in the last seven years of being an investor in your Company. Is this because you have reached a certain scale? Or is this because something specific happened during this quarter? Or is it something we should expect in the future? How can you clarify that huge amount of growth on the gross profit part?

There are a few things there. Really, the big drivers are coming out of the Grains and Foods Group, as we mentioned on the call. Continued growth in our value-added processing, aseptic package and alternative beverage, which is obviously at a higher margin than a lot of our single handle, commodity-type sales. So, our mix is trending there. As well as we've got improvement in the sunflower division, whereas last year we weren't doing as well. That certainly helped lift gross margin as a percentage. And overall, just good volumes and good returns on some ingredient offerings and rationalizations, primarily in the Consumer Products Group at the frozen foods division, where year-over-year improvement as us exiting those unprofitable lines of business have really helped that lift.

Would you say that this type of growth is something we should expect in the future -- the same type of ratio? Moving forward, if you grow -- the same type of profit margin in the future?

Yes, that's the whole point. We're after growth, and Steve outlined in a previous caller's question -- what we're doing to get to that 8% margin, and that is the ultimate goal and that is the target. We are certainly headed in that direction.

Okay, last question in regards to Mascoma. I know that they filed for an IPO some time ago. I was wondering if there is any color you can give us or any updates you can give us on where they are at this point? Or when we should expect them to actually go public?

From what we know at this stage, Ron, the S-1 is there. The market -- the IPO market for CleanTech, from our observations, and I can't speak for Mascoma. But from our observations, it is pretty tough. I do know in reading that a company called [Koskata] and another one called [Enercam], I believe, who had S-1s in the market have withdrawn. Along came Facebook, to scare everybody to death about IPOs.

So, my take -- and I can't speak for Mascoma, but our observation at this stage is that the market is probably not real warm these days. I do know that they are continuing to work away diligently at a number of the initiatives that they have ongoing, and they are making great progress. Who and how and when they might decide -- I couldn't speak for them. And we really don't know for sure.

Yes, I agree with you. Facebook definitely did a few special things to the market that improved investor confidence. But as much as we really need it. On a serious note, I do think that if there was timing for it, with the new outcry about corn -- battle of food versus fuel. That may be good timing to go public. But again, it's up to them.

By the way, we agree 100%. Using food for fuel as much as energy security is really, really important. You really get a sense for it when you see supply dwindle up around the world this year because of drought, and other places that are soaking wet. Energy security really is important, and I couldn't agree more. But using food is -- I would agree that cellulosic-type application should have some wheels, and we will see.

The core business is growing exponentially, and then you have these two non-core businesses -- the Mascoma ownership and Opta Minerals still doing well. It's just really a matter of time before you divest out of those and create some other value.

You're absolutely right. Take care, Ron. Good to chat.

Thank you. Keith Howlett from Desjardins Securities.

Yes, some questions on the resealable pouch business. How diversified is your customer base there? How competitive is that market? Or have you got secure relationships that will carry you forward there?

We don't disclose customers. But, look, we have a diversified group of customers that we are working with, and that grows as we grow our capabilities. So, we're really happy with that. There's a lot of pouch-filling capacity coming online, but we're differentiating our product offering and our processing capability. So, we are really quite excited about the future.

It's amazing. I just saw, Keith, some statistics the other day. The global pouch market -- guys, correct me -- 1.8 billion pouches currently. And the US is only 300 million. It's very developed in Europe. I think there are 650 million or 700 million pouches currently in Europe. And in Asia, it's quite developed. This is a developing market here.

We have really assessed it, and said -- we just don't want to be another pouch-filler. We are not today, because we are an integrated processor, and we source the raw materials and we process the raw materials and we put them into a package. But, longer term, our intention is to differentiate our capabilities. Obviously, focused on natural and organic and not belly-washed juice or stuff that's not good for you.

So, in terms of the US, you are a very significant player. You'd be about 25% to 30% of US industry capacity?

No, not right now. We will be, but not until we are up and commissioned and running and that type of thing. But it is our intention to be a significant supplier.

Would there be anyone else in the organic space who is doing pouches?

Yes, but I don't think any of them are vertically integrated. We might actually be selling some of the ingredients some of the time.

Great. On the aseptic beverage business, which is a very strong performer, I had a couple questions there. One, what components are growing? And also, how your sunflower test pilot product worked out?

Sorry, Keith?

I'm sorry, my phone may not be very good. I was wondering how the sunflower aseptic product, I think, that you were testing, how that was going?

The sunflower is going well. We haven't thrown a lot of big marketing dollars behind it, so we've done a lot of marketing via social media and those sort of things. But the listings continue to increase. The volumes continue to grow. We continue to streamline and improve the processing and product quality. So, it's growing. It's not a real big part of our portfolio at this stage, but certainly one that has great potential to grow.

You were asking about the other components within aseptic?

Right.

The real fast grower these days is almond milk. We have processed and packaged almond milk -- 20% year-over-year lift, Rob? Probably growing around 20%. The soy category as a whole has declined. Ours hasn't because we have been growing, but it's not growing at 20%. It's very stable as the category matures, but we do continue to pick up customers. And rice is in that zone -- a little bit of growth as well.

And then, on the WhiteWave spin-out from Dean Foods, you had a long historical relationship with WhiteWave. Do you think that there will be opportunities with them? Or there will be long-term supply agreements between Dean and WhiteWave?

Yes, we really don't know at this stage of the game. I suspect that there will be long-term arrangements in place between Dean and WhiteWave. We are a supplier to all of those companies in various categories. And they are a wonderful company. We will see -- early days. We hope. That is why Rik is here. He is going to figure that out.

No pressure.

No pressure, Rik.

And then, on the snack business -- the healthy snack business. In terms of the distribution network that you are utilizing, I presume it's mostly third-party sales. Just wondering, to continue to drive that business, I know it has grown a lot in the past few years. Is there anything you need to do on the distribution side to triple that business sort of thing?

Yes, a couple of things, Keith, that come to mind to your question. First off, the bulk of our customers are private label -- are retailers. So, it's their distribution system that really drives that more so than us. We do use distributors to deliver to retailers that aren't big enough to have their own distribution -- their own warehousing system. We're still continuing to look to expand -- to snacking operations, the fruit snacks -- expand that to the East Coast. But it's not really a distribution play so much as a capability and cost play to serve retailers around the country.

That feeds into my next question which was private label, retail-based products. How big do you think your business now is at private label across all of your diverse product lines?

There's a couple of answers to that question. I can tell you that about 40% of our revenues are in finished packaged products, and that continues to grow. But a lot of our raw material and ingredient offerings will end up as ingredients and raw materials in private label, finished packaged products that we don't specifically pack. So, to give you a number on how much of our business goes directly into private label, that would be a hard one. We would have to assess every customer and who they are producing for. We sell an organic grain that ends up in organic cereal under somebody's brand or private label, and that I don't know. I would be guessing.

Just a question on the grain business. I know most of the year-over-year gross margin came from the value-added products and the oils and the sunflower. But how does it actually work on the commodity business? It mentions there was improved gross margin from the grain-selling business. Is that very opportunistic that your margins are high when the market is tight? Or do you work to a percentage margin or a margin per ton or bushel? In other words, is that margin very opportunistic quarter-to-quarter depending on the markets?

What I would say is, the way we look at that business is what we call the handle. Every time you touch a pound or a bushel of one of those commodity products, we're looking to get a certain margin in cents per pound or dollar per bushel. And then, when you have inflated commodity values, we look to get a little bit more to cover the increased working capital costs that we have because our inventory values are higher. But I think it's fairly stable, and there's a little bit of uptick in high commodity markets because we are looking to get more to cover our working capital costs.

I see, great. Just a question on the -- it's a very small part of the business -- the Lorton juice business. I'm sure that between the international sourcing and other channels, there is a plan for the business. But I was just wondering, what is the plan for the Lorton business?

We have been making a number of upgrades to the facility so we can incorporate production that we want to put into the facility. And that, to be honest, it's taking longer, and it has cost us more than we had initially hoped. That's one of the impacts on the consumer products business. But we have a number of products that we have processed at third parties that we want to move into that facility. We are needing to make the upgrades before we do that. We're in the process of doing that at this stage.

We also want to leverage the integrated capabilities there because they can extract juice, et cetera, that we have done at third parties and move it to there as well. We have been making upgrades to the facility, and some of those have been complicated by some supply challenges on organic citrus. We have the citrus, but it didn't get to the proper Brix levels and that sort of thing in a timely manner. So, that has all been a part of it. But we're working away at Lorton's and having that value-added packaging capability is important to us long-term.

Just finally on Europe, Mr. Jacobs has come from Europe. Are you thinking that you will begin to open aseptic packaging plants in Europe? Or other value-added manufacturing in Europe?

Look, we are looking to take our core competencies that differentiate us from other people, and those core competencies are our sourcing and supply capabilities, and our integrated processing capabilities around -- in grains, fiber, and fruit. Our strategy is to leverage those capabilities where we can. So, clearly, we're very familiar with the European market. We're not looking to move into those markets and do anything other than leverage our capabilities into those markets either through starting businesses or through acquisition. We have a presence in Europe, and we continue to look there. There's a number of geographies that we are very interested in, and we're working to do that.

Great. Finally, I noticed that there was a move in ingredients from one division to the other. Is the ingredients division between food and consumer-packaged? And is that pretty well -- everything is where you want it to be now?

Yes, at this stage, it is. All we had there, Keith, and it was between the Ingredients business and the Grains and Foods business. There was a particular product line that made more sense, because just the Grains and Foods Group was producing it. You produce it, and you sell it, too. Let's not get transferring internally. One of the big initiatives that John Ruelle has been leading is just simplifying the back-end of our business and streamlining it. It's a very low margin piece of business, but it's very important for utilization of the facilities, et cetera. Let's save an accountant and save a tree and stop doing that extra paperwork.

Great, thanks very much.

Thanks, Keith. Take care.

Scott Van Winkle, Canaccord Genuity.

Hi, thanks. Good morning. Most of my questions have been asked and answered. Just a follow-up on the commodities. What percentage of your raw material input purchases is corn?

20% --?

Soybean is the engine that drives our value-added. So, corn is the smaller piece of it. I don't have the number handy, but it's going to be one-third or less, I would say.

Less than one-third.

Great. And following up on the commodity side. How long does it take [past your] price -- is it one of those things where in a couple of months you get visibility, and you call up your customers and say -- here's what it looks like; it is going to be X% high? Or is that how it plays out? Or is it a longer process?

Scott, John is going to jump in, but one of the things that happens, which is part of our process is, we contract. So, for the most part, we only talk to our customers -- the value-added customers. That doesn't apply to grain transactions, which are much more -- hand-to-mouth sort of thing. But we enter into a contract for soy milk for a year with a customer -- we've contracted and have established the price we are going to pay the growers. That's one of the benefits that we bring. We are contracted. Here's the price.

We can tell our customers what the price is. And that is essentially the price on the raw materials side for the year because we have contracted. We know what the supply is, and we know what the price is that we are paying. So, we are able to save our -- I can't remember in my 11 years, times where we have gone mid-year strictly over raw material. We may have to go because of packaging changes or the price of natural gas shooting through the roof or whatever. But, John, it's very seldom do we have to talk mid-season.

Yes. Steve is right. Our cycle there on the commodities side -- it is an 18-month cycle. We are writing a contract with the grower in the Spring in North America. That inventory is going to come off the field in the Fall and be our cost basis for our inventory until the next harvest. We have already been having numerous communications with our customers over the last four or five months about what they should expect going forward in those value-added ingredient accounts.

Really, the only risk is the quantity of available product and/or quality, not so much price?

Correct. The calls we are getting are not much right now about prices, just confirmation of availability and whether we are going to be able to supply them through next year. As Steve mentioned earlier, we are well positioned to look them in the eye and say -- yes, we will.

Perfect. And then, on the other end, the demand side. With the growth you have seen at retail -- consumer interest in natural and organic products. You are starting to see the mass market maybe adopt at a little faster rate then we have over the last couple of years. Is that evident to you from the standpoint of customers calling you for new product formulations? You get a call from someone, you're like -- wow, I can't believe they are calling about natural and organic?

Literally, every major retailer are in or getting in on healthier options. And our take -- the demand around the healthy eating umbrella continues to grow. It can be natural. It can be organic. It can be fiber-enriched, gluten-free, allergen-free, whatever the case might be. That continues to grow, and it is -- when I started -- I'm starting to sound old, but when I first started on this it was more of a natural health play in natural health arena. Every retailer is into this now.

I was thinking -- I was asking, or trying to ask -- has there been any change in the pace of that adoption? Or have you seen anything? It has just been an ongoing trend of more and more interest?

Yes, and the real interest is in innovation. What is new for the category.

Great, thank you.

Thanks a lot, Scott.

I show no further questions at this time, and would like to turn the conference back to Mr. Steve Bromley for closing remarks.

Great, thank you very much, and I really appreciate everyone joining us on the call today. To conclude, we are very pleased with how things are going, and we are excited. I know everyone is concerned about commodity and crops, and rest assured that we are all over that, and spend a lot of time dealing with that. If we have a dramatic change, we will certainly let everyone know. But we feel like we are in decent shape, thanks to our global supply chain.

As always, please feel free to call Rob or myself. Call Rik, too, because he's been here six days, so he will at least give you some answer, and John as well. We really appreciate your time, and have yourselves a great day. Thanks.

Ladies and gentlemen, thank you for your participation in today's conference. This does conclude the program, and you may all disconnect at this time.