John B. Sanfilippo & Son, Inc. (JBSS) Q1 2018 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and welcome to the John B. Sanfilippo & Son Incorporated First Quarter 2018 and Fiscal Year Conference Call. At this time, all participants are in a listen only mode. Later, we will conduct a question-and-answer session and instructions will be given at that time. [Operator Instructions] As a reminder, this conference call may be recorded. I would now like to turn the call to the Michael Valentine, Chief Financial Officer. You may begin.

Thank you, Nicole. Good morning, everyone, and welcome to our 2018 first quarter earnings conference call. Thank you for joining us today. On the call with me is or are Jasper Sanfilippo, our COO; and Jeffrey Sanfilippo, our CEO. Before we start, we want to remind participants that we may make some forward-looking statements today. These statements are based on our current expectations and involve certain risks and uncertainties. The factors that could negatively impact results are explained in the various SEC filings that we have made, including Forms 10-K and 10-Q. We encourage you to refer to these filings to learn more about the risks and uncertainties that are inherent in our business. Starting with the operating result recap, net sales for the first quarter of fiscal 2018 decreased by 3.4% to $214.8 million in comparison to $222.3 million for last year’s first quarter. The decrease in net sales came mainly from a shift in sales volume from higher priced almonds, pecans and walnuts to lower priced peanuts and trail mix products. Sales volume which we define as pound sold to customer was unchanged in the quarterly comparison. Sales volume increased by 14.7% in the contract packaging channel from an increased sales of trail mixes and snack bite cluster products to existing customers. Sales volume in the commercial ingredients channel declined by 17.1% as a result of the loss of a bulk almond butter customer that occurred in last year’s second quarter. In the consumer channel sales volume increased by 1.8% primarily from increased sales of almonds and trail mixes to existing private brand customers. Sales volume for Fisher recipe nuts fell by 5%, this decline in volume occurred because the major customers preparing to replace small and some medium size Fisher package sizes with private brand recipe nuts. Fisher snack nuts volume decline by 9.1% as a result of reduced merchandising activity and Orchard Valley Harvest sales volume increased by 10.2% mainly from expanded distribution of OVH multi-pack items. Gross profit for the first quarter of fiscal 2018 decreased by 4.5% to $34.8 million. And gross profit margin decrease to 16.2% of net sales in the current quarter from 16.4% last year’s first quarter. The decreases in gross profit and gross profit margin were mainly attributable to higher acquisition cost for pecans and cashews. The shift in volume and product mix that I mentioned earlier also contributed to the decline in gross profit dollars. Total operating expenses decreased to 8.1% of net sales from 8.7% for last year’s first quarter and total operating expense dollars declined by $1.9 million. The declines in total operating expenses as a percentage of net sales and in dollars primarily resulted from declines in incentive compensation, base compensation and amortization expenses. Interest expense in the current first quarter increased by $200,000 the increase in interest expense was due to higher short-term debt levels. The total value of inventories on hand at the end of the current first quarter increased by $18.7 million or 12.7%, compared to the total value of inventories on hand at the end of the first quarter of last year. The increase in total inventory value was mainly attributable to higher acquisition cost for pecans and cashews. For that reason, the weighted average cost per pound of raw nut and dried fruit input stocks on hand at the end of first quarter of fiscal 2018 increased by 50.1% compared to the weighted average cost of raw input stocks at the end of last year’s first quarter. Net income was $10.4 million or $0.91 per share diluted for the first quarter of 2018 compared to $10.2 million or $0.89 per share diluted for last year’s first quarter. Both the earnings measures represent record results for first quarter. And now I will turn the call over to Jeffrey Sanfilippo, our CEO, who will provide additional comments on our operating results for the current first quarter. Jeffrey?

Thank you, Mike. Good morning everyone. This is the fifth consecutive year that company has reported record first quarter operating results for net income and diluted earnings per share. And we continued our goal of returning profits to our stockholders by paying our first ever annual dividend of $0.50 per share and supplemented that with a special dividend of $2 per share. The company achieved these results despite the unfavorable impact on gross profit that resulted from higher acquisition costs for pecans and cashews and the shift in sales mix to lower price products. The earnings improvement largely came from a reduction in total operating expenses, particularly compensation expenses. I am proud of our results at start of fiscal 2018, we have seen acquisition cost for most domestic tree nuts and cashews increase in the 2017 crop year, which falls into our current 2018 fiscal year. Because of this increase combined with significant competitive activity in the marketplace, the company experienced gross profit and margin declines this quarter as Mike mentioned. Our management team is keenly aware of the importance of maintaining margin and expanding it where possible. Three key areas we are focused on, first we will continue to build our brands and transform our business and that of our customers with profitable product, packaging and processing innovation. Second, we will continue to strive for continuous improvement across our company with a special focus on operational efficiencies to reduce costs through our manufacturing and supply chain. And third, we are assessing our SG&A expenses and corporate structure to optimize our investments in talent across the organization. As I mentioned in the press release a major customer informed us that they will be replacing small and some medium packaged sizes of Fisher recipe nuts with private brand recipe nuts. In preparation for this transition, this customer purchase fewer branded recipe nuts during the first quarter than it did in last year’s first quarter. Consequently we expect that challenges in growing the Fisher recipe nut brand from our strong fiscal 2017 performance will continue during the remainder of fiscal 2018. We anticipate that this reduction in Fisher recipe nut sales will have an unfavorable impact on net sales, sales volumes and gross profit. However, we plan to continue building our strong Fisher recipe nut program and maintaining our number one market share brand position. We have already picked up several new retail customers for Fisher recipe nuts and expanded distribution with other current customers. In addition, our company is in the strong position to mitigate the volume loss by driving performance through our multiple sales channels and enhancing our product portfolio. We believe that the declines in net sales and sales volume for Fisher recipe nuts should be offset by continuing sales volume growth in contract packaging, food service, private brand snack nuts and trail mixes and Orchard Valley Harvest produced products in fiscal 2018. These anticipated sales volume increases coupled with the decrease in compensation expenses for fiscal 2018 should largely offset the anticipated decline in gross profit in such future quarters. To support sales volume in fiscal 2018, we also intend to direct additional resources and our expanding consumer reach growth strategy by focusing on product lines that are tailored for alternative retail channels. Volume growth across all our channels is critical, so we must understand and follow the consumer. This is a transformational time for every CPG company. A significant shift in buying behavior for not only what consumers purchase, but where they purchase it, it’s transforming the retail landscape, strong growth in e-commerce, the discount channel, and the club channel is dramatically changing market dynamics, health and wellness, non-GMO, Nord [ph] official ingredients, organics, gluten free are all on trend topics, when you read discussions about the food sector. So, we’re reallocating resources to adapt to these changing market dynamics and consumption trends. Turning to category updates in the snack, recipe and produced segment, let me share a view of our brand performance and consumption trends. As always, all the market information I’ll be referring to, is IRi-reported data, and for today it is the period ending September 24, 2017. When I refer to Q1, I’m referring to 13-weeks of the quarter, ending September 24. Reference to changes in volume or price are versus the corresponding period, one year ago. We look at the category, on IRi’s total U.S. definition, which includes food, drug, mass, Wal-Mart, military and other outlets unless otherwise specified. When we discuss pricing, we’re referring to average price per pound. Breakouts of the recipe, snack and produced nut categories are based on our custom definitions, developed in conjunction with IRi. And the term velocity refers to sales per point of distribution. First, let me review some overall category dynamics. The total nut category increased in sales dollars by 3% and pound volume by 2% in Q1. Overall prices in Q1 increased 1%, versus the prior year. Pricing in cashews and peanuts increased for Q1 7% and 5%, respectively. These pricing forces led to a 4% declined in pound volume for cashews, but pound volume increased 2% for peanuts, versus the prior year despite the higher price. Price decreases on pistachios, almonds and walnuts by 11%, 10% and 5%, respectively, versus last year resulted in a 32% pound sales increase for pistachios, a 10% pound sales increase for almonds and a 1% increase for walnuts. Now, I’ll talk about each category in a little more depth, starting with recipe nuts. In Q1, the recipe nut category was flat in dollar sales and increased 5% in pound volume sales. A 6% decrease in walnut prices, resulted in an increase in pound sales of 4%. While pecans managed a 5% increase in pound sales, while prices held flat versus a year ago. Almonds, a smaller portion of the recipe category decreased 4% in pound sales, despite an 8% price decline. We believe consumers migrated to other parts of the store to purchase almonds, as we saw snack almonds increased 13% in pound sales, and produced almonds increased to 5% in pound sales. Our Fisher brand started our fiscal year on a strong note, continuing the momentum from last year. Our brand equity efforts on Fisher helped the brand deliver growth in Q1. Fisher recipe nuts increased 4% in dollar sales and 7% in pound sales for the quarter versus last year. As a result, Fisher share in the category increased 0.06 versus last year. The growth was driven by an increase in ACV, which shows retailers are embracing the Fisher brand. Fisher recipe nuts has an ACV distribution of 63%, which is a 7 point increase versus last year. With the brand share growth over the last five years, Fisher continues to be the number one brand in the recipe IO [ph] and multiple outlets, in all outlet reporting. Now, let me turn to the snack category. In Q1, the snack category was flat in dollar sales, and decreased 1% in pound sales. Fisher snack decreased 5% in sales dollars, and 4% in pound volume sales in Q1. The decrease was driven by a decrease in merchandising activity, versus last year. The company has struggled with our Fisher snack brand, trying to find a differentiated position in the marketplace. However the marketing and sales teams, will be executing a new Fisher snack program at the start of Q3, and we’ll share more details on our future call. Orchard Valley Harvest produced nut brand was down 13% at IRi reporting customers due to lapping significant promotional programming. Shipments increased 10% versus last year due to growth at non-IRi reported customers. Total points of distribution increased on Orchard Valley Harvest as a major retailer expanded more OVH items into their sets. We continue to build on core business success by launching new products such as our anti-oxidant mix and our heart healthy blend, both in multi packs along with a line of salad toppers that has gained recent distribution. We will update you on the performance of this line in future calls. In closing, while we face competitive challenges every year that impact our company, we have proven our ability to manage through volatile markets. We will continue to work closely with our customers to provide value and leadership to build their nut and snack programs. We do have volume challenges and headwinds going into the remaining quarters of fiscal 2018, just as we had this time last year at the start of fiscal 2017 with a loss for a major industrial customer. But the management team and all our dedicated employees have a steadfast commitment to develop business opportunities that create shareholder value and provide relevant profitable value added products and services to our customers and consumers. We appreciate your participation in the call, and thank you for your interest in our company. I’ll now turn the call back over to Mike.

Thank you, Jeffrey. At this time, we will open the call to questions. Nicole, can you please queue up the first question.

Thank you. [Operator Instructions] Our first question comes from the line of Francesco Pellegrino of Sidoti & Company. Your line is now open.

Good morning guys.

Good morning.

Hi, Francesco.

So, I guess I’ll start off by saying this was a very nice quarter for you guys, despite some of the headwinds that you had addressed in your commentary. I guess, I want to start off by saying, just the commentary that was incorporated into this earnings release has evolved quite a bit from the fourth quarter and it just seems as if you guys were completely blindsided by the actions of one of your largest customers. And I was just wondering why there wasn’t maybe better dialogue with that customer, was it just due to maybe the timing of when contracts are renegotiated, when pricings renegotiated. Just a little bit of color here, I’d appreciate just because it just seems as if this came out of -- completely out of left field?

Sure this is Jeffrey, Francesco I will answer that. So we had some visibility in Q4 about the decisions of this major retailer. We anticipated that in our fiscal planning process for fiscal 2018, however within a month into Q1 of 2018 that retailer expanded their private brand decisions in the recipe category. That was news to us going into Q1 of this year. So we thought we had some transparency understanding the dynamics, but changed dramatically in that first period of 2018.

So if at the time in the fourth quarter we saw them expanding their private label brands and you thought that you were going to have the benefit of selling to that customer into a depleted inventories then you must have thought at the time that the total category was going to be expanding?

We are -- so we are under the impression that there was only certain private brand items that were going to be replacing Fisher in these sets. And we had planned for that, however the news came that they were actually resetting the stores they expanded the number of private brand items that were going on the shelf. And so there was more of a dramatic effect on our volume because of that result, which we were not aware of in Q4.

Okay. I am just thinking about how to ask the next question, because I know there is going to be some sensitivity in your answer. Over the past couple of years, you got some very nice growth with Fisher. In 2016 you had year-over-year growth of 17%, that was about a $25 million change, then in fiscal 2017 we had an $11 million drop, mostly due to actions taken in the second half of fiscal 2017. And when I just start looking at the change in your Fisher branded portfolio and I start comparing this with the -- your largest customer and what your largest customer has represented in regards to revenue, did a majority of the revenue increased in 2016 come from your largest customer and then a majority of the revenue decrease in 2017 was that also attributable to your largest customer?

So it’s a little bit of a combination the majority came from that largest customer both the increase in 2016 and some of the declines in 2017. But I will say we are critically aware of the importance of expanding our customer diversification and our sales and marketing teams have done a great job building Fisher recipe distribution at other retailers. And as I mentioned earlier today we have expanded that distribution with a couple of new retail accounts which are significant and we continue to add more items in some of our current customers outside of that largest customer.

Okay. Help me quantify the impact of this lost business with this single customer, because when I look at the year-over-year changes in the third quarter of fiscal 2017 and the fourth quarter of fiscal 2017 given the fact that the first quarter of the 1Q fiscal ‘18 10-Q hasn’t been released yet. It could be pretty dangerous to start extrapolating some of these trends going forward. Your branded portfolio was down $5 million in 3Q ‘17, in the fourth quarter it was down $12 million what was that number like in the first quarter of ‘18 on a dollar basis?

You’ll see that in a couple of days Francesco when we file our Q.

Okay. So you’re still going to be selling larger Fisher bags at this single retailer. So it looks as if it’s just going to be some of the smaller bags as a result the product or the volume that was in the smaller bags where will you be selling it now?

So all the other major retailers that we have distribution for our Fisher recipe program we will continue to sell those smaller size bags.

But you’re going to need a significant uptick at these from expanded distribution to offset this lost business. So if you can’t get this incremental if you cannot set this business with new customer wins or expanded distribution how would this flow to other parts of your channel sales? Potentially because I would not think that you would be doing private label pecans or walnuts with -- for this customer?

Okay. So Francesco we still intend to buy the same amount of pecans we bought last year to fuel growth at other retailers with Fisher recipe. In the event that we have extra pecans we can sell those in the commercial ingredients channel. We’re going into a pretty low carryover year, yet to be seen what this pecan crops like, but there’s always an opportunity to get those pounds in commercial ingredients. And then of course in the case of walnuts we’re actually looking at a much smaller walnut crop than what was expected. Walnut prices are rising, this does free up some walnuts for us to sell into the commercial ingredients channel at some pretty high prices.

Okay. I'm going to yield the floor for now, but I’ll jump back in queue. Thank you.

Okay, thanks Francesco.

Thank you. [Operator Instructions] Our next question comes from the line of Bruce Winter, Private Investor. Your line is now open.

Thank you. Reading from your 10-K our principal products are raw and processed nuts these products accounted for 82% et cetera of gross sales. What is the difference between the 82% and the rest as far as the way the management to runs the company, it thinks about the company, invest in the future, allocates resources, etcetera?

Okay. While the other 18% are comprised of confectionary products, other snack products like for example sesame sticks and then of course dry fruits. As far as how we allocate resources we really look at our business as a whole, we’ve allocated resources primarily to our operations and primarily to our shelling plants where our primary opportunities for both growth and profitable growth occur.

So recipe nuts are in the 80%, Orchid Valley Harvest is in the 82%?

Part of Orchard Valley Harvest there is a lot of dry fruit in Orchard Valley Harvest. So part of that is in the 18%.

So like a bag of Orchard Valley Harvest who has nuts and dry fruit you allocate part to nuts and part to dry fruit.

Right.

Okay, I got it. And just one more question. In the press release, you talk about snack bite cluster products. What is the difference between that and nut exactly?

It's basically the same thing. But these particular cluster products we make for our contract packaging customers.

How is the nut exactly going for cluster…

Sure. So overall the cluster line is doing well, we have invested in some important equipment in our Elgin facility. One of our business model benefits is that we've got multiple channels. So if one of our brands that we launched like Nut Exactly is not as successful as we anticipate, we'll try to sell that capacity to other contract manufacturing customers, which is exactly what we've done this year. The Nut Exactly program, great idea, great launch we think it's a great product. We had a little bit of a value price proposition that consumers were concerned about. So we pulled it off the market at this point, and we’re looking at the brand and the product portfolio and we'll reconsider doing something in the future with that brand with Nut Exactly. But in the meantime our focus is on building our capacity on those lines to our contract manufacturing channel.

Great. I think it's a very great product too. And so now you pay down in dividends, what I paid in my stocks. So all the stock I have now is free, so I'm a happy shareholder. Thank you very much.

Hey Scott, glad to hear you.

Thank you. And our next question comes from the line of Scott Jones of PW Capital [ph]. Your line is now open.

Good morning. Considering in the current environment the increasing of store branded product is a growing trend. How can you have confidence that this isn't going to be a recurring theme with other large customers switching to their own store brand as appose to yours? Thank you.

Okay. This is Mike, we've been around for a long time and we've seeing Private Label Recipe nuts trying to enter the category outside of club. And it's never really been very successful. So that's why we feel confident that overtime and especially considering the amount of trust we've built in the Fisher recipe nut brand, that we can get back to where we were.

Okay, thanks. And also if you have the growth opportunities to sort to make up for these sales. And why weren't you pursuing those in the first place?

Yes, we constantly are pursuing additional growth opportunities and have a contingency plan in place for challenges like this. It just takes times to build new distribution, takes time to launch new products. We've got a lot of stuff in the pipeline that was pushed into Q2 that we are expecting to hit in Q1. So we are constantly building contingency plans in the pipeline for new growth. It just takes a little bit longer than we anticipated. But we’ve picked up some good wins. Thank you.

Thank you. And our next question comes from the line of Francesco Pellegrino of Sidoti & Company. Your line is now open.

Alright I'm back. Maybe before I jump back into some of the tough questions. Just a little bit of commentary on Orchard Valley Harvest, because in the year ago press release. Just looking at the growth that Orchard Valley Harvest experienced. Shipment volume was up 193% in 1Q fiscal '17, the fact that you got 10% volume growth off of that was really, really impressive. And I'm wondering if this is potentially the item that can offset loss Fisher recipe sales just given the acceleration in Orchard Valley Harvest volume growth and maybe where you see that going forward, because that was really impressive in the first quarter.

Thank you. And that is a big focus for the company, it's been a very successful brand launch. And as I mentioned on the call, we just expanded that to include salad toppers. We've got new distribution that just hit stores in Q1, the end of Q1 actually. So we're very optimistic about making up some of that volume loss on the recipe side with our Orchard Valley Harvest program. Not only just gaining new distribution with our current product portfolio, but now with the expanded product portfolio and with the NA oxidant mix, the hard healthy mix and now this new salad topper program.

Orchard Valley Harvest growth is now coming off of a growing base and just given where your change at retail has been for Orchard Valley Harvest obviously it's not being captured accurately there in the IRi data that you provide us with. Who are you exactly sung as Orchard Valley Harvest to, is it like sea stores? Is it to a lot of smaller customers? I'm just sort of wondering about the quality and when I say quality I sort of mean more so in regard to size, distribution, market share, of the type of customers that you're getting the incremental distribution gains from?

Sure, so part of it is alternative channel, we've got new distribution or have distribution in alternative channels, which is the focus of the company, mass merchandising we’ve got distribution there in the produce section at a major mass retailer. We just gained new distribution at a club retailer, which is brand new business for us. So the brand is really cross channel supported and we're now looking at some of these in the food service channel as well. But really it's mass, it's grocery, it's club and alternative channel, but the brand plays in all of the channels.

And Francesco, when we talk about alternative channels in respect to OVH we're talking about non-food retailers.

What percentage of OVH’s sales are from non-food retailers?

I would guess probably something like 25%, if I am right Jeff?

Okay. Moving over to your inventory, so on a dollar basis inventory is up 13% cost per pound is up 50%. This would imply roughly that the volume that you're sitting on is about 35% to 40% lower than in the year ago period. So I'm not sure if this is just differences in regards to maybe sitting on more raw material input stock as compared to maybe less finished goods, if we're seeing on maybe heavier in shell walnuts. Could you just give us a little bit of inside into where your inventory position is in regard to maybe like the product mix?

There was significant decline in quantity on our raw nut input stocks and that primarily fell with walnuts last year at this time we had a significantly higher level of walnut inventory than we have right now as you may recall.

So was walnut inventory last year elevated or are you short walnut inventory this year, which one would be normalized?

Right. It was higher than what is typical, last year.

Okay. So we're seeing a normalized walnut inventory right now?

Right.

Okay. Can you maybe just discuss such as we're going to be seeing some of the harvest coming through especially for what you're vertically integrated for? Where your positions are right now for pecans?

Yes, so pecans we’re well positioned. We're anticipating a large to decent size crop this year, lot of growth in the U.S. crop, Mexico looks a little bit down from the prior year. We're anticipating a nice size crop. Our position is perfect going into this new crop. We tried knowing that we come off of a very expensive pecan crop we came in with going into the new crop with a short position and so we're -- the harvest has just begun. We're trying to see product come out of the U.S and a little bit out of Mexico now. We went into this crop trying to be short because we knew of the high level of cost that we had in our inventory. So from pecan standpoint, we're in a very good position.

So you're in a very good position right now with your pecan inventory because you’re short pecan inventory, but your inventory dollar sales are up quite a bit from the year ago period despite being on -- despite having less volume. So I would think that in the second quarter potentially and third quarter you're going to be needing to buy a lot of -- as you always do let's be honest expensive pecans. And I'm just wondering where that inventory number could really be? And it's going to be a strain on your working capital?

Well we -- I mean the harvest is just coming in now. We do not anticipate paying the high prices that we paid this prior year for pecans directionally.

Okay. And I guess just my last question for you, as you guys have identified alternatives in which you are going to be tackling this lost Fisher recipe business with this single customer, and it's going to come down to volume growth in contract packaging, private brand sales growth and continued growth in Orchard Valley Harvest. You are going to need...

Yes, I would just add and food service as well.

Okay, and food service. Just when you start thinking about just what type of volume growth you’re going to need from these categories as well as changes in the product mix. You’re going to need a lot of things to go right here to offset the lost Fisher recipe nuts business. And believe me if any management team can do it, it's probably you guys because you guys have done such a great job with this business over the past decade. My question to you is, is the base business outside of the branded portfolio in a position where we can see significant improvement?

There are major opportunities Francesco in outside of just the branded business. Our private brand business is still very strong, we pick strategic retailers that we can work with to grow their private brand business. We've some opportunity now that we're pursuing. So certainly the volume opportunities are there to replace that business, but we're still keenly focused on our own brands as well. I don't want to negate the fact that we are building brands, our Orchard Valley Harvest brand is a good example, we're not going to give up on Fisher recipe, we're going to continue to maintain that number one brand position, and there are still a lot of customers that do not carry Fisher recipe at this time that we are going to pursue. We have a great brand store, we have brand equity, we've demonstrated that we can grow the recipe nut category for retailers where we have distribution. We're just going to continue to focus on building that success and expanding it.

And I apologize, just one more question. So, just thinking about how fiscal 2018 is going to be evolving and I'm not sure if maybe I should be using as a read through the lower incentive compensation that you guys accrued in the first quarter as what the company’s internal and non-communicated outlook for the rest of the year is. But given the significant decline in the administrative expenses by about 20%, it looks as if the reduction in gross profit dollars will be offset by lower incentive compensation that year-over-year your fiscal 2018 pre-tax income should be theoretically in line with your fiscal 2017 pre-tax income, which was record earnings for the company. So it seems that we will be able to sustain potentially possibly this level of high earnings, but no earnings growth for the next year, two years?

Francesco, this is Mike. That’s basically what we're anticipating, but I do want to remind you that we do need continued growth in contract manufacturing and private label snack nuts and trail mixes and OVH that continued growth is also part of that offset.

Okay, perfect. Thank you so much guys.

Okay, thank you.

Thanks, Francesco.

Thank you. And that is all the questions we have today. I would now like to hand the call back to Michael Valentine for any closing statements.

Thank you, Nicole. This completes our call for our first quarter fiscal 2018. And we thank everyone for your interest in JBSS.

Ladies and gentlemen, thank you for participating in today’s conference. That does conclude the program, you may all disconnect. Everyone have a great day.