MGP Ingredients Inc (MGPI) 2006 Q4 法說會逐字稿

At this time, I would like to welcome everyone to the MGP Ingredients Inc. fourth-quarter earnings conference call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer period. (OPERATOR INSTRUCTIONS).

It is now my pleasure to turn the floor over to your host, Ladd Seaberg, CEO. Sir, you may begin your conference.

Okay. Good morning to all of you, and we certainly welcome you and thank you for joining us on this conference call to discuss our fiscal 2006 fourth-quarter results.

I am joined this morning by Brian Cahill, who is Vice President of Finance and who is our CFO; Tim Newkirk, who is our Chief Operating Officer; and Steve Pickman, who is Vice President of Corporate Relations. I will begin with a brief review of our fourth-quarter performance and then provide an update on our Company's strategy, after which we will open the call to any questions you might have.

We ended up the year on a very strong note, with all the gains in income driven by our distillery segment. We continued to get the benefit of higher selling prices of our food grade alcohol products, as well as fuel grade alcohol, or ethanol.

The ingredients segments, on the other hand, is our biggest challenge, where we continue to struggle with top-line growth, product mix and higher wheat costs. The primary factor behind lower revenues this year has been a decline in sales of Chewtex resins used in pet industry products. Following a change in ownership of our single largest customer, there have been no sales of this product since May. MGPI has recently filed a lawsuit against the customer and its new owner.

Meanwhile, we have many exciting new products and partnerships currently being commercialized and are optimistic that over the next several quarters, we will overcome the negative financial consequences of the loss of this important customer should a resolution not be forthcoming.

Another factor that adversely impacted our profits in the fourth quarter was the cost of wheat, representing about one-half our cost of goods sold in this segment. Wheat prices for the fourth quarter averaged 25% higher than a year ago.

Now let me give you some financial highlights. For the fiscal 2006 fourth quarter ended June 30, we had net income of approximately $7.4 million or basic earnings per share of $0.45 compared to a net income of $732,000 or $0.05 per share in the prior year's fourth quarter.

Our sales for the fourth quarter increased by 22% to $90.3 million. For our distillery segment, fourth-quarter sales increased 51% over the same period the prior year. The major contributor was substantially higher pricing, combined with increased unit sales of fuel grade alcohol, supported by improved prices for food grade alcohol.

Referring to the table of segment results in your news release, you can see that pretax income for our distillery segment in the fourth quarter was $20.3 million compared with a loss of $227,000 in the prior year. Lower energy costs, specifically natural gas prices, also factored into this sizable improvement.

For the ingredients segment, fourth-quarter sales declined by 30% compared to the prior year. The main reason was a 68% drop in sales of specialty ingredients for non-food applications, principally the Chewtex line of pet-related products, as stated earlier.

Our specialty ingredients for foods improved by 5% from the year-ago levels, due mainly to higher sales of specialty proteins and Pregel specialty starches, while sales of Fibersym resistant starches and Arise wheat protein isolates declined from prior-year levels. They did show sequential gains from the third quarter. Throughout the entire fiscal year, our specialty ingredients segment has operated at a loss. The decline in sales of pet-related products has been a major setback, but it only exaggerated the ongoing impact from product mix and higher wheat costs.

Our distillery segment, on the other hand, experienced a banner year, driving a significant improvement in earnings performance. For all of fiscal 2006, we had a net income of approximately $14 million or $0.87 in basic earnings per share on sales of $322.5 million. That compares to net income of 4 million or $0.25 in basic earnings per share on sales of $275 million for all 12 months of fiscal 2005.

Additionally, as we reported in our news release, we benefited from recognition of approximately $850,000 in state income tax credits, which reduced the effective tax rate for the fiscal year ending June 30.

That completes the financial summary. Now let me move back to the outlook and our strategy. Our outlook really has two parts. First, we aim to optimize profits on the distillery side by making the most of favorable market conditions while successfully managing our cost of goods sold.

As a reminder, our two distilleries are essentially producing at their maximum annual combined capacity of approximately 110 million gallons. While we have plans to improve operating efficiency across our plant network, most of the profit improvement in the near term will be driven by higher market values. Remember that in May, we reported we had contracted a sizable portion of our total alcohol capacity to our fuel customers through the end of calendar 2006, taking us through our first quarter of fiscal 2007. Consistent with forward market activity, these contracts were at higher prices than were in effect during the year-ago period.

Our strategy on the distillery side has not changed, with cost leadership being the key to long-term profitability. This is the charge of our Chief Operating Officer, Tim Newkirk. He is spearheading the evaluation of projects that will allow us to generate incremental volume from our existing client network.

Our outlook for specialty ingredients essentially depends on our ability to replace lost sales of pet-related resins and to improve sales in the product mix and food applications. The focus is clearly on profitability. As you know, we are reviewing the entire operation, including raw material costs, our new product development process, and our marketing and distribution channels. Our best chance of success lies in maintaining our R&D lead in starch and protein technologies. The food industry is very much focused on creating new products that are nutritious, delicious and convenient.

Our basic plan is to gain a greater share of business from our core customers on the ingredient side. By freeing up the costs associated with non-profitable products, we can redeploy technical and selling resources to provide a much stronger team which is totally focused on customer solutions.

Much of our progress will come from realigning our sales and product development people across a narrower range of specialty ingredients. I want to stress that this is more than a cost reduction exercise. We have to rethink our mission. For instance, who is our best customer and who is not? We must understand the total cost of each product line and be able to achieve specific profit targets.

MGPI is really on the verge of a new era. The new course we are charting is to take -- will take into consideration the business opportunities, as well as the risk we see. We are focused on value creation with a keen eye on investing in projects that generate returns well above our cost of capital, maintaining financial flexibility with strong cash flow and a solid balance sheet, and returning excess cash to shareholders where appropriate.

This concludes our prepared remarks. Before taking questions this morning, I need to add that any forward-looking statements we might 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 to vary materially from our expectations. Additional information about these factors may be found in reports we file with the Securities and Exchange Commission, including our Annual Report on Form 10-K and Quarterly Reports on 10-Q.

With that said, we are ready to open the line for any questions you might have.

(OPERATOR INSTRUCTIONS). Tony Brenner, Roth Capital Partners.

A couple of things, Ladd. First of all, in the previous couple of quarters or few quarters, your distillery mix had been shifting pretty sharply towards food grade alcohol from fuel grade. This quarter, it was the opposite of that. And I'm wondering if the reason is your forward contracting, or is there some other explanation?

Tim, go ahead.

This is Tim. I will take that one, Tony. Essentially, we have continued to maintain about a 50% split between food grade and fuel grade of the 110 million gallons that we talked about in our Q3 earnings call as our current realizable capacity. I'm not quite sure why you have the impression that we have changed that split.

Well, my impression was gleaned from the fact that food grade sales had increased much more dramatically than fuel grade sales. And my impression is you are making an effort because of higher prices in that direction, the fact you get a low bit more premium in food grade to make that happen. I guess I was wrong.

Thanks for clarifying that, Tony. Let me kind of clarify that. From a volume perspective, we are maintaining our strategic commitment to our food grade. The reason that you're seeing that big an increase in fuel grade is about unit prices and the market strength in the fuel grade area.

Secondly, you mentioned that you have forward-contracted a significant portion of your capacity through the end of the year. Judging from the timing of when you have been talking about this, it would seem that the contracting is roughly at current market price levels. I wonder if you could shed a little light on that, and maybe on what a significant portion of your capacity is numerically.

You bet, Tony. As noted in the earnings release, alcohol prices in general were higher in the fourth quarter than we saw in the third quarter. The prices in the first and second quarter were primarily contracted during that same period, as you note. In a sense, we really believe that fuel grade ethanol, as well as our food grade prices, will remain relatively stable over the next two quarters.

Subsequent to that, we have also done some contracting beyond -- into our Q3 and Q4, and those will have occurred during the March to June timeframe. As it stands today, we are approximately 50% forward-contracted on our total volume.

For the year?

That is correct, for the fiscal year.

And one final question. On the ingredients side, the reference was made to new products. Are there any now of those new products in commercial distribution? Or are all those still in market test? Is there anything out there with real traction at the moment that might become a sales driver over the next couple of quarters?

Tony, this is Tim again. The Wheatex line, the texturized wheat protein line that is not new has been receiving dramatically more emphasis by our sales staff and out in the market. And we are starting to really gain some traction on the texturized wheat front, especially in the export markets. We're still having a pretty tough go domestically, but we are having some good traction in the export markets.

The other product that we are very excited about is our FiberRite RW, which is a line extension in our RS4, the resistant starch technology platform, that we announced in June at the IFP show and featured there. This starch is our fiber source, as is our Fibersym 70 line, but it is also with the additional benefit of being an outstanding performer as a fat replacer. This double benefit in a single ingredient solution will open a whole host of new applications for our resistant starch platform that have not been accessible previously.

In some instances, this FiberRite RW, Tony, is beginning to move into commercial and out of testing. So this one is kind of right on that brink. And we expect to start seeing some commercial sales beginning in our third quarter or late second quarter.

Jonathan Lichter, Sidoti.

Just a question -- how high can you -- do you think you can get that alcohol capacity to, beyond the 110 million gallons currently?

Jonathan, this is Tim. I will take that one. In the Q3 earnings call, we discussed our intention to develop specific engineering plans to de-bottleneck our alcohol production processes to realize the permanent production capacity based on the existing environmental permits.

As we discussed at that time, pending Board approval of the capital, this would result in an increase to capacity by approximately 15 to 20% over the 110 million gallons per year that we have currently. We are in the final evaluation stages and plan to present to our Board for review by the end of the summer. Timeline for completion of those projects is estimated to be 12 to 18 months when we get the go-ahead from the Board.

And in terms of the ingredients business, what is the timeframe there for profitability?

That is a very good question. As we talked about, as Ladd talked about in his opening comments, we continue to focus on improving margins through reduced sales of commodity-based products and increased sales of the higher-valued specialty products.

As we've noted in previous calls, many of the higher-valued specialty products are coming from a much smaller base than the commodity products and will take some additional time. We have implemented the detailed cost reduction and control strategies Ladd has mentioned, and we will continue to redouble our efforts to improve the performance in this area.

That said, with the dramatically reduced winter wheat crop that has just been harvested and the resulting high winter wheat prices, which obviously are the main raw material, the ingredients segment performance is not expected to experience much if any noticeable improvement during the first half of FY '07. That said, Jonathan, we do expect to start seeing improved performance in Q3 and Q4.

Do you think you could, I guess, approach profitability in Q3 and Q4?

I would say approach is a fair assessment. I think we can approach profitability.

And then the other question I just had, in terms of the corporate expenses, I saw, were a bit higher. What were some of the components there?

The corporate expenses were higher because of some additional health care reserves that we had for the period, along with incentive plans and also our ERP system. Those are the three major areas.

(OPERATOR INSTRUCTIONS). Steve Denault, Northland Securities.

When you referenced the ingredients segments as being continued weakness in the first half, is that relative to the kind of weakness that we realized in the June quarter, or that sort of $2 million run rate loss that you realized in the December and March quarter?

This is Tim. I will take that. That is really, Steve, a function, again, as we've talked about before, with the higher-valued specialty products at a small base and the commodity products at a very large base, it is really about where the raw material costs are. And so the raw material costs that we were able to achieve in that third, fourth quarter area, still carry forward compared to first and second quarter.

That said, we also had the pet issue that we are in the middle of working our way through, both from the litigation perspective, but also from some exciting new market opportunities. So I would say we will be somewhere actually in between the two as we go forward.

Okay, and then improving in the balance of the year.

Correct.

On the distillery side, it is good to hear you're forward-contracted on the 50% of the production for the full year. Is there -- I know the June quarter was a very, very good quarter from a pricing standpoint. Is there reason to believe that you could -- let's just say you did 40 million in operating income within distillery in fiscal '06. Can you beat that in '07?

That is a tough question. This is Tim. That's going to be dependent on a lot of things, Steve. Obviously, that is dependent on the rate that new capacity is coming online, specifically in the fuel area. It is going to depend on where corn actually ends, because if you remember, we started this last previous fiscal year at some very, very attractive corn prices in that $2 or sub-$2 range. It is going to depend on where oil stays, and gasoline relative to oil. There's a lot of things -- a lot, a lot of variables.

That said, we still feel very strong where the market is going to finally settle out. Relative to the 40 million, I can't really say. If you just go back and look at the main inputs, corn is, relatively speaking, close to where we were. Natural gas is at at least that level if not better. And gasoline and oil are very strong right now.

(OPERATOR INSTRUCTIONS). Doug Feldman, SC Fundamental.

Wanted to follow up -- I guess the last caller was asking a little bit of the question about the distillery segment. And maybe I could ask the question a little bit differently. You were running in the fourth quarter at sort of maximum calling capacity. And I assume that in the first quarter of fiscal year '07 you are going to be running at maximum capacity as well. Based on that, the pricing that you have in your forward contracts -- should we assume that that is similar to the pricing you obtained in the fourth quarter?

That would be a fair assumption.

So then we should be looking for roughly, order of magnitude, plus or minus a little bit, around the 71-ish million of revenue in the first quarter for distillery.

That would be correct.

And then also, I think what you just said, and correct me if I'm wrong, is that the pricing for your inputs for corn and for energy is at least as favorable as it was in the fourth quarter.

Yes.

Yes, this is Brian. I think that is pretty fair as far as -- we've seen a little volatility in both of those markets, but the first quarter is going to be very comparable to the fourth quarter.

So then both from a sales and a profitability, the first quarter on the distillery side we should expect to be relatively similar.

I would say that is true.

And then, I guess, as we're trying to model out past the first quarter and onwards, I guess what you're saying is your profitability and your sales really are going to be driven by, one, what you could get for on your sales price, but that is sort of locked in for at least the next couple of quarters, and then what happens with your input prices.

That's correct.

That's correct. And we have locked in some of the input prices for both corn and natural gas.

So barring changes -- so all else being equal, is it fair to assume that that business could generate 80 million of profitability this year, assuming that you got the exact same pricing and you had the same input costs?

It would be premature to make that type of an evaluation at this point.

Fair enough. That answers the question. I appreciate it, guys.

At this time, there appear to be no further questions. I would now like to turn the floor back over to Mr. Seaberg for any further or closing remarks.

Okay. It's certainly an exciting time for MGP Ingredients. Our legacy distillery operations are well-positioned to benefit from strong industry conditions. With new management in place and a renewed focus on Company-wide productivity, we see opportunities for our integrated segments to create additional value for our stockholders.

Thank you for again joining us this morning, and we look forward to talking with all of you again when we report our first-quarter earnings. And this concludes our call at this time.

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