MGP Ingredients Inc (MGPI) 2005 Q4 法說會逐字稿

Good morning and welcome to the MGP Ingredients fourth-quarter earnings conference call. At this time, all participants have been placed on a listen-only mode in the floor will be open for questions following the presentation. It is now my pleasure to turn the floor over to your host, Ladd Seaberg. Sir, you may begin.

Good morning and thank you for joining us on this conference call to discuss our fiscal 2005 fourth-quarter and full-year financial results. With me this morning is Mike Trautschold, Executive Vice President of Marketing and Sales; Brian Cahill, our Vice President of Finance and CFO; and Steve Pickman, our Vice President of Corporate Communications.

The story of our fourth quarter was similar in many respects to our third quarter, and indeed to our entire fiscal year, in that sales of specialty ingredients were subjected to unfavorable comparisons to the prior year's low-carb related sales surge. What differed in the fourth quarter versus the other three periods in fiscal 2005 was that our fuel alcohol business experienced price weakness, while energy costs rose due to higher than anticipated natural gas prices. These and other factors created an additional drag on our performance, which led us to our recent adjustment of guidance for fiscal 2005.

When comparing our fourth-quarter performance to the immediately preceding third quarter, our earnings per share dropped by $0.05. This resulted from a $0.16 earnings per share decline in the distillery segment, which was partially offset by an $0.11 earnings per share increase in the ingredients segment. Due in no small measure to the pricing volatility we are experiencing, we have decided to forego the practice of issuing specific earnings guidance. It has always been extremely difficult to predict swings in such costs as energy and grain, as well as selling prices for our distillery products, particularly fuel grade alcohol.

I would like to address the concerns any of you may have had as a result of this decision by assuring you that we will remain as open and as transparent as ever in our public communications. Although we will move ahead without the diversion and necessity of making any adjustments to EPS estimates, we will endeavor to update our progress on strategic initiatives and operational benchmarks in as much detail as possible and as frequently as possible.

In that spirit I will now proceed with a review of our fourth quarter results and conclude with a look ahead to fiscal 2006 before opening the call to your questions. Fourth quarter concluded a year of great transition for MGP Ingredients. The low-carb product surge of 2004 obscured the fact that we were still early on in our shift to a specialty ingredients focus. We have now returned our focus to growing a strong and diverse portfolio of specialty ingredients.

Our technological expertise and long-standing status as innovators in grain ingredient science continue to result in exciting new products coming to market. Many others with compelling customer application prospects continue to move through our pipeline. In some of our most important product areas, we continue the positive sales momentum that has marked fiscal 2005 on a sequential-quarter basis.

Fourth quarter's Fibersym sales, while down slightly versus third quarter, were up dramatically compared to the first two quarters of the year. Sales of our patented wheat-based resins for pet applications continue their year-long sequential increase with other excellent performance in the quarter. Our Wheatex line of textured wheat proteins, which are sold for use in meat and the seafood analogs, as well as meat extension applications increased for the second consecutive quarter.

As a result of continued success on the starch side, we have produced more commodity wheat gluten as a coproduct of increased wheat starch production. As to inadequate (ph) opportunities to further process all of our protein into value-added specialty proteins, selling it as wheat gluten is the next best option. Anyone familiar with our history knows this is not a market we care to return to. Clearly our goal is to increase sales of specialty wheat proteins, and we continue to make progress toward developing and marketing products on that side of the production process.

Extensions of our Wheatex line, including our Wheatex RediShred varieties and newer products targeting vegetarian, seafood, and soup applications, are being received favorably in the market. We are also making progress towards the development of new products in our Arise line of wheat protein isolates that we believe possess exciting market potential.

On the distillery side, the decrease in the price of fuel alcohol contributed to a slight decrease in overall distillery sales compared to the year's fourth quarter. Sales of higher food grade alcohol increased 49%. As many of you know our state-of-the-art distillery operations in Atchison, Kansas, allow us to produce alcohol of the highest grade for a host of commercial and beverage applications. We believe our long history in the business of alcohol production, which stretches back to the 1940s, as well as our proven experience and capabilities, position us well to pursue any opportunities that come our way.

An interesting distillery opportunity that presented itself last week when President Bush signed into law the new energy bill, which among other things calls for a near doubling of the use of renewable fuels to 7.5 billion gallons by the year 2012. We should benefit from this development as long as increased capacity in the industry does not outpace demand and usage.

To recap our financial results, net income for the fourth quarter was $732,000 or $0.05 per common share, compared to $3,164,000 or $0.20 per share in the period one year ago. Net sales totaled $73,949,000 compared to $78,995,000 in fiscal 2004 fourth quarter. Results from specific product groups on both a quarter-over-quarter and sequential quarterly basis are as follows.

As I stated earlier it is obvious that our Fibersym resistant starches decreased compared to last year's fourth quarter, which we have mentioned often represented the high water mark of our sales related to the low-carb diet trend. Sales of Fibersym were down slightly compared to the fourth quarter, but still up significantly versus the first two quarters of fiscal 2005.

We remain excited about the early performance of FiberRite, capital RW, a recent addition to our portfolio of resistant starches which we launched at the International Food Technology Expo last month. Continued emphasis on healthy lifestyles is expected to create good demand for ingredients that increase fiber content and decrease fat content in foods. FiberRite accomplishes both and can do so in a wide array of new applications like yogurt, sauces, ice cream, and salad dressings without sacrificing taste or texture.

Sales in our Wheatex line in the fourth quarter also decreased compared to last year's fourth quarter, due primarily to lower demand for Wheatex use in certain low-carb formulations. On a linked-quarter basis, Wheatex sales increased versus the third quarter, which was the second consecutive sequential quarterly increase. We also expect Wheatex to benefit from a number of newly developed applications, as I mentioned earlier.

Sales of Arise wheat protein isolates decreased versus the year ago, again driven by reduced low-carb demand. Unfortunately, Arise sales also continue to trend downward on a sequential basis, due to competitive pricing pressures. As previously mentioned, we are focused on developing new additions to our line of wheat protein isolates that we expect will be better able to compete amid pricing pressure in the marketplace and will open new applications for these ingredients.

Sales in our non-food specialty ingredients area are more than double compared to the fiscal fourth quarter of -- to the fourth quarter of fiscal 2004, driven by increased demand for the line of protein and starch-based resins for use in the manufacture of pet chews and related treats. On a linked-quarter basis, sales of non-food specialty ingredients increased more than 30% compared to the third quarter. We're excited about the opportunity to further expand our presence in specialty non-food ingredient applications.

On the distillery side, total sales of our distillery products were $47,313,000 in the fourth quarter, compared to $47,482,000 for the same period in the prior year. This slight decrease was principally attributable to a 20% decrease in sales of fuel grade alcohol, combined with a 26% decrease in sales of distillers feed, which offset the 49% increase in sales of food grade alcohol.

As mentioned in today's news release, the drop in fuel alcohol sales was due to a decline in selling prices, which fell more than we had previously anticipated. However, as we also announced we have already begun to see prices improve from their fourth-quarter level. The decrease in sales of distillers feed, the principal byproduct of our alcohol production process, was due to lower prices compared to the prior year's fourth quarter. Prices of corn and milo, our principal raw materials for the alcohol production processes, were down approximately 32% compared to the last year's fourth quarter.

We enter fiscal 2006 in a good position to capitalize from favorable trends in both segments of our business. Now that we are one year removed from the low-carb anomaly that occurred in fiscal 2004, we are confident that our capabilities and resources are much more closely matched with those opportunities.

I would like to point out that compared to two years ago, fiscal 2005 sales revenues from our ingredients segment increased 60%, driven by a nearly 88% increase in sales of specialty ingredients. Breaking this down further, it is worth noting that sales of our specialty ingredients for food applications grew by 62% compared to fiscal 2003.

Along with efficient operations we will go to market with a growing base of intellectual and scientific capital and a growing reputation in the marketplace as the provider of choice for truly customer-centric solutions. We look forward to sharing our successes with all of you in the year to come.

Before taking questions this morning, I need to add that any forward-looking statements that we might have made -- that we make today are qualified in the following respect. There are a number of factors in addition to those already mentioned that could cause our actual results and guidance to vary materially from our expectations. Additional information about these factors may be found in our reports that we file with the Securities and Exchange Commission, including our annual report and Form 10-K and quarterly reports and 10-Q. We will now take your questions, and I'm going to turn it back over to Dave, our operator.

(OPERATOR INSTRUCTIONS) Tony Brenner of Roth Capital Partners.

The shortfall in earnings was blamed partly on lower-than-expected specialty food ingredients. In your release and from your comments it is difficult to discern what exactly was lower than expected. Wheatex, which had been soft improved sequentially. Arise, which had been soft, simply remained soft. So where exactly was the surprise there?

Tony, this is Mike Trautschold,

By the way, Tony, I'm going to kind of act as moderator on this end and designate which one is going to answer the question, so we don't all talk at once.

Okay.

Go ahead, Mike.

I have been tapped to answer this one. Tony, the specific product line in the specialty ingredients sales that did fall short was the Arise protein. It was the Arise protein that was use in a lot of these baking applications as the protein boost in type of low type -- low-cal type of operations or applications that have not come back as quickly. That issued was exacerbated by the fact that we had attracted additional competition when we were in the sales surge associated with low-carb.

So as we tried to state concisely, in the Arise proteins had fallen off, and yet we were still selling an awful lot of starch. So we continued to make the protein fractionate. That protein, when not being able to be sold at the more premium priced and higher margin Arise line, got sold as flash-dried gluten.

As you well know, that product is not protected like some of the starches are. It was one of the very first specialty ingredients that we made, and so it was not protected from a patent standpoint.

Okay.

On a sequential basis, as Ladd pointed out in his comments, basically the segment actually showed an earnings per share growth fourth quarter over third quarter. (multiple speakers) actually showed growth over third quarter. It was unfortunately offset by the issues of the pricing and the energy issues in the fourth quarter on the distillery side.

I think the other thing that entered into it, Tony, was that we produced more flash-dried gluten in the quarter. The sales were better in the ingredients area for the fourth quarter, but some of those sales were in flash-dried gluten, which is a low margin or no margin. Also the way that we value our inventory is at lower cost to market; and so that had some effect also in the quarter.

Okay. Secondly, with respect to some of the new products that you have developed and are beginning to market -- FiberRite and the new Wheatex products -- how long is the process before these can be expected to have -- be a meaningful contributor to revenues?

Once again, it's Mike, Tony. I would say a minimum of six months. FiberRite, which is our most exciting new product, in my mind, is this starch which will be a patented product -- and it is predicated on the science and the patent from actually Fibersym -- will function as a partial fat replacer and a fiber enhancer. As we had said in the release I think, even, its applications are not so much along the baking line, because it's going to be in viscous things like yogurt, ice cream, sauces, things of that nature.

We launched that at the IFT show in New Orleans, which is the biggest international food ingredients technology show of the year. Had a lot of interest in the product. Are just beginning to send out these product samples right now, which is the first step. Then our customers begin to evaluate it and experiment with it in formulations of their new products. But realistically, any significant volume cannot be expected in anything short of six months. We have put a little bit of that product into our sales expectations for this fiscal year. But we really are not counting on large volumes of that. Because it will take six to 12 months to see real action.

On the side of the Wheatex applications, those probably will come about a little bit quicker than, say, a year; I would be more on the six-month range there. Those products, especially the dry soups and some of the vegetarian applications, are sold primarily in Southeast Asian markets, and we have been actively showing that product in those areas. In some ways these products were actually developed for those specific applications. So I would like for a little bit faster acceptance of those products in the marketplace.

Some of the other Arise work that we're doing right now is we have expressed that part of our issue has been price competition. So we have been very actively working on a series of alternative methods for making and producing this product, which will result in some price alternatives, pricing decreases now. These products may not be an exact match for Arise in all applications, but we also believe that in some of the -- hopefully the large volume applications, this new cost-reduced alternative would function favorably; and we will hopefully be able to get some of that business back.

Those businesses generally speaking are put forth on six and 12-month contracts. We're certainly trying to be in a position that at the end of this calendar year, as some of these contracts come up for renewal on an annual calendar basis, we can be in a position to hopefully get some of that business back. Again we have put some of that business back into our expectation for this fiscal year; but in the short term, things just don't turn that fast in the ingredient segments.

One last point, on your income statement, what is other comprehensive loss that apparently to about a penny a share?

That is the effect of hedging in the future, that is taking the hedging that we have got going forward.

Why is that treated as a nonrecurring items? Your fully diluted earnings then are actually $0.04, not $0.05?

The fully diluted earnings are the effect of stock options on the earnings statement. The comprehensive is just the effect that hedging has in the future.

I am still curious why you're reporting your earnings as $0.05.

Based on the basic shares, it is the net income before the comprehensive income. That is just the accounting rules that we would report it on net income before comprehensive.

You're reporting the basic share?

Yes, yes.

Thank you.

(OPERATOR INSTRUCTIONS) Steve Denault of Northland Securities.

I would like to ask a follow-up to the FiberRite question. Can you provide a little bit more color just in terms of, was this a line extension that you developed on your own? Or was the impetus a food manufacturer coming to you saying we think we have got potential use for this particular ingredient?

Steve, it's Mike again. It was one that we developed more on our own. We recognized that probably our strongest customer base and application base has historically been in the baking industry and perhaps the pasta industry. We recognized that in order to diversify our portfolio, both of our products as well as our customer base, we needed to stretch our applications into new areas.

One of our scientists in particular who had worked on the basic Fibersym product began to see some opportunities for additional modifications of this product, so that it would provide this fiber enhancement (multiple speakers).

So to that extent, he is listening to the customer.

Yes, and clearly we saw the applications. Yogurt is a very rapidly growing category. Even the ice cream, as ridiculous as this sounded to me the very first time I heard it, there's a lot of interest in fiber applications in ice cream. If you do some basic Internet searches, you will find a lot of interest and even products that have been experimented with by the major ice cream producers. I think it is primarily the U.S., but it may even be an international market.

Certainly, we believe that two major health trend issues are going to continue. This issue with fiber is certainly a new one, and it is growing very rapidly. But the interest also in fat reduction has really not declined very much. So FiberRite really offers a great opportunity to address those two specific issues. Indeed it was something that we conceived as a legitimate food trend, and it was an application that we could create with a fairly broad base of usage.

How much of the FiberRite would one have to use a yogurt -- let's just (indiscernible) General Mills -- to make -- can they make any sort of claims, fiber claims on the package itself?

Yes, based on the individual application that would be conceived and how it is used, we can go anywhere, I think, from a good fiber to an excellent source of fiber claim.

Okay. Interesting. How about -- I will just change speeds here. What is your outlook? Realizing that you're not providing any sort of guidance, what should we anticipate the potentials for distillery operations going forward? Is fiscal '06 the year where you can make money?

Steve, this is Brian. At this point, where we're at, definitely the distillery should make money in fiscal '06. Currently, I guess the biggest factors in that area are obviously the selling price for the alcohol, the grain prices, and the energy prices that we pay for natural gas.

But from I guess just looking at some of the numbers, and I will just throw some ranges out. The Chicago Board of Trade's future ethanol prices have moved up significantly. They probably averaged in the area of $1.25 in our forth quarter. They are currently trading on that $1.70 to $1.80 range. Some days higher than that. So that is a significant increase in ethanol prices. Not that our prices follow that exactly, but basically the market moves in that direction.

The other thing as far as grain is concerned, it has been a very volatile period for corn prices specifically in the last two to three months, but the crop generally is not a disaster. The USDA's report last week was a little bearish to corn; and the current price for grain is around 2-30 for new crop corn, a little less than that today. So that is (multiple speakers) --

(multiple speakers) contracts were good for 2000 (multiple speakers)?

Natural gas, on the other side has moved up, and that is part of just the overall energy complex. We do use natural gas. Part of our strategy over the last few years has been continually to put in energy-saving equipment, so it takes less natural gas to make a gallon or a pound of our product. So that is looking pretty good. But natural gas prices going forward, again have been volatile. We do have a strategy in place to try to minimize the cost there, but we do have higher cost. But overall, I think net-net of all of those factors, the distillery looks positive in the -- at current period and then (multiple speakers)--.

Currently at this point it does.

Going in the future, that is where it gets a little bit more difficult to predict. But currently we expect the distillery to make money this year.

Can it do as well as it did in fiscal '05?

I believe -- I guess the other thing to add to that, we continue to try to improve in our sales of high quality alcohol. That is more of a stable market. We think that is a real benefit going forward to keep margins positive. So we feel pretty good about that market right now.

Okay. So from a -- have you entered, on the sales side, have you entered into any forward contracts? Is there any percentage of your capacity on the fuel grade side that is already sold?

Yes, we do sell some forward; and we look at margins when we do that. We try to lock margins in when we make those sales. But we have a lot of gallons available in the spot market also.

Okay. How much hedging do you do in the input cost, to the extent that you can?

Our strategy has always been to try to protect ourselves from natural gas for the winter period in a percentage of anywhere from 50% to 80%. So we try -- we are in that process right now. As far as grain, we have some protection there on grain prices going forward. So we look at it kind of as an overall combination of what we can hedge. With the ethanol futures out there now, that gives -- that is a new contract, but I think that will give us another tool going forward to lock in some sales prices going forward also.

Okay. One final question. Any update on the Cargill partnership?

The Cargill partnership is moving along, as there is really no specific changes from where we were. I really don't have any comment on it. There is some litigation is (ph) obviously being measured relative to the national lawsuit against Cargill for this high amylose patent rights. I really don't feel it is appropriate for me to comment on that. On the other hand, the tapioca license that we issued to Cargill as part of our overall arrangement has been moving forward. I did notice at the Cargill booth at the IFT show in New Orleans that they featured two products that were made from their tapioca-based resistance starch. So I view that as a positive opportunity for us relative to the business alliance that we had formed on that front.

Okay, thank you.

(OPERATOR INSTRUCTIONS) It appears that we have no further questions at this time. I would now like to turn it back over to Mr. Seaberg for any closing remarks.

We certainly thank everyone for listening to today's conference. We certainly appreciate the confidence that they have had in our stock, and look forward to attendance in future calls. We will live up to our pledge to disseminate the best information possible in going forward. Okay, thank you very much.

Thank you. This does conclude today's teleconference. Please disconnect your lines at this time and have a wonderful day.