MGP Ingredients Inc (MGPI) 2007 Q1 法說會逐字稿

Good morning. My name is Lynn and I will be your conference operator today. At this time, I would like to welcome everyone to the MGP Ingredients Fiscal 2007 First Quarter Earnings Conference Call. (Operator Instructions.) It is now my pleasure to turn the floor over to your host, Ladd Seaberg, Chairman and CEO. Sir, you may begin your conference.

Okay. Good morning to everyone. We certainly welcome everyone, and thank you for joining us on this conference call to discuss our fiscal 2007 first quarter results. I am joined this morning by President Tim Newkirk, Brian Cahill, who is Vice President of Finance and our CFO, and Steve Pickman, who is President of Corporate Relations.

I will begin with a brief overview or review of our first quarter performance and Tim will comment on some of our growth and improvement initiatives. We'll then open the call to your questions. As you read in our release, our earnings performance continues to be driven by our distillery segment where the fundamentals remain solid. With unit volume comparable to our year ago levels, revenue gains in the distillery came primarily from significantly higher pricing.

Production levels, as well as production efficiencies, are expected to improve as a result of recently announced plans for a series of distillery equipment upgrades. These upgrades are designed to increase our alcohol capacity by about 15% over our current maximum annual capacity of 110 million gallons. We expect to have all of the new capacity online by the end of the summer of 2007.

The ingredients segment, on the other hand, continued to show negative sales comparisons caused mainly from lower unit sales of specialty ingredients for non-food applications. This again was most pronounced in sales of Chewtex resins used in pet products. We lost a major customer last year and have had no sales for them since May. On a positive note, we did achieve pet product revenues in the first quarter from the addition of new customers and new product innovations.

As part of our efforts to turn the segment around, we have been phasing out certain specialty food ingredients that generated very low or negative returns. When combined with improving manufacturing yields and better cost efficiencies, we've produced a significant improvement in segment performance compared with the fourth quarter of fiscal 2006. Our aim is to begin to achieve operating profitability by the end of this year, if not sooner.

Let me begin--let me provide some financial highlights for our first quarter. We had net income of nearly 7 million, or fully diluted earnings per share of $0.41, compared to net income of 3.7 million, or $0.23 per share in the prior year quarter. Income from operations for the quarter was 10.7 million pre-tax, compared with 6.6 million pre-tax a year ago. Our total sales for the quarter increased by 10% to approximately 85 million.

For the distillery segment, the first quarter sales increased 26%, compared to a year ago. The major contributor was a 34% increase in sales of fuel grade alcohol, driven by higher pricing. Food grade alcohol products achieved a 21% increase in sales for the quarter. Within this category, sales of alcohol for industrial applications rose by 20%, while beverage alcohol sales grew by 25% above the prior year's first quarter.

Referring to the table of segment results in our press release, you can see that pre-tax income for our distillery segment in the fourth quarter was 15.2 million, compared with a 6.9 million in the prior year period. This clearly demonstrates the operating leverage from higher selling prices since lower energy costs were not as much of a factor relative to a year ago.

For the ingredients segment, first quarter sales declined by 29% compared to the prior year. The main reason was a 66% 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 dropped about 12% from year ago levels as part of the Company's planned reduction of certain products. While overall unit sales declined, however, we did not see an increase in our average selling prices, largely as a result of an improved product mix.

This is in line with our goals to set--to get a higher percentage of our core ingredients into the sales mix. With a renewed focus on our Fibersym and FiberRite resistant starches, Arise wheat protein isolates and Wheatex textured proteins, we expect to see improving sales momentum in subsequent quarters.

That completes kind of the financial summary. Now let me turn the call over to Tim for more commentary on our growth initiatives. Tim?

Thank you, Ladd, and good morning to everyone. As I stated in our news release, we are focused on executing our plan to drive profitable transaction growth. In the ingredients segment, this means eliminating low return products from our lines and concentrating our efforts on maximizing our high value product capacity. In comparison to fourth quarter results in this segment, the reduced first quarter loss in ingredients indicates that we are making headway.

Selling prices for our specialty food ingredients were up in the first quarter while unit sales were down. This resulted from a shift in our product sales mix, buoyed by a planned decline in lower valued commodity wheat gluten and the execution of greater efforts to place sales, marketing, and production emphasis on the higher valued specialty proteins and starches.

We are now organized around key technology platforms, placing increased focus on core products, which at this time include our Fibersym, FiberRite, Arise, and Wheatex lines in the food area.

In the pet products area, we are further developing our role by moving up the value chain and increasing our capabilities to bring retail ready products to our customers. As I stated previously, the early success of this strategy is encouraging. In all of the markets we serve, we know that we can add greater value and be appropriately compensated if we respond to customer initiatives by working directly with their in-house R&D and product development groups. This is another important component of our strategy, which we are already equipped to effectively execute.

To increase the success rate, our ingredients technicians and application specialists are being much more proactive as part of a customer facing team focused on total solutions. These are a few of the highlights of how we plan to grow our business and return ingredients to a more positively impacting role in our Company.

Now I would like to turn the discussion back over to Ladd.

Thank you, Tim. For the second quarter, a significant portion of our fuel grade alcohol sales are contracted at prices comparable to those in effect in the first quarter. However, our distillery earnings in the last two quarters of this fiscal year could be impacted by fluctuations in fuel pricing and likely higher corn costs. Our priority for this segment is to maintain high levels of profits and cash flows.

While we aim to maximize distillery profits until our new capacity comes onstream, we look to our specialty ingredients segment to help drive earnings growth as the fiscal year progresses. The first step in turning things around was to get our cost structure in line and to place a greater emphasis on fewer key product groups. The reduced loss in the ingredients segment this past quarter, compared to the first quarter of 2006, shows that we are beginning to execute on the food side. Even though it is likely to develop over a longer period of time, our pet division has also great potential to contribute to future profit growth.

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 and guidance to vary materially from expectations. Additional information about these factors may be found in reports that 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 will open the line for any questions you might have.

Thank you. (Operator Instructions.) Our first question is coming from Tony Brenner of Roth Capital.

Thank you.

Good morning, Tony.

Good morning. Tim, you suggested that in the specialty ingredients area that the Company would be focusing on four products lines - Fibersym, I think FiberRite, Arise, and one other that I didn't get.

That's the Wheatex line of texturized wheat protein.

Okay. What proportion of specialty ingredients sales do those four product lines company--currently comprise?

They're certainly small relative to the overall. I would say probably in the neighborhood of 15 to 20% of our total specialty ingredients, Tony. They're certainly starting from fairly small base numbers, but the growth rate in those even as--looking at our subsequent numbers here in the last month or so, really are starting to grow at a pretty good rate.

Okay. But if 80% of those specialty sales are flat or down and you've got 20% that's growing, I guess I'm having a hard time understanding how this division can stabilize by the fourth quarter.

Well, not all of the 80% that are not the highlighted products are necessarily low margin products. A lot of those are what we call now our heritage products that have been with us for 20 years that have consistently generated very nice margins, very nice returns, and are already highly value-added products. It's just that they're not new technologies. They're very good products, very important products. And our growth is really focused on the new technologies that have come out of R&D in the last couple of years. But those are certainly--that other 80% are still very strong performers.

Are they growing?

They're growing, yes, but at slower rates than those highlighted products.

Okay. Switching to the distilling area. I believe it's been your Company's practice in prior years to hedge a large proportion, if not all, of your natural gas requirements for the winter. Have you done that this year as well?

Yes, Tony. We've--consistent with the past year, we've hedged 80% of our non-contracted volumes for the winter. And we look at that to take us through the February time period.

What about corn?

Corn, as we talked about, we have hedged our sales. We are about 50% hedged through the rest of the year for both alcohol sales and input costs for natural gas and corn. Natural gas, we're a little bit higher because we do some hedging for the winter period.

Were those--last question. Were those corn hedges put in place prior to the run up over the last two months?

Yes.

Okay. Thank you.

Thank you, Tony.

Thank you. Our next question is coming from Steve Denault of Northland Securities.

Good morning.

Good morning.

Hello, Steve.

Just following up on the last question. The corn was hedged at--it was at 50%, did you say?

We have hedged for the rest of the fiscal year - the last nine months - approximately 50%.

Okay. What about in terms of ethanol pricing? It sounds like you've entered into some forward contracts through December. Anything--do you have anything going for March?

Yes. We have--this is Tim. We have--we're always selling in different segments. Some are three months, some are spot, some are six, some are nine, some are 12 months. So we have all sorts of different layers, which allows us to be more effective on the risk management side at hedging. We are obviously, as we've talked about in previous calls, more completely sold in the current quarter or the current months as we would be in out months.

So it is--consistent with what Brian just talked about on the corn side, about 50% of our total alcohol production is also pre-sold over the next nine months. Now, that's obviously in decreasing quantities as we continue throughout the year. So Q2 is certainly much more sold than Q3, and Q3 is more sold than Q4.

Okay. Thanks, Tim. Any developments on FiberRite?

FiberRite is continuing to undergo quite a few tests within several different customers' laboratories. We hope we have the first--probably the one that's closest to being fully commercialized from our customers' perspective should start rolling out in Q3. So we're really excited about getting prepared to ship our first FiberRite here shortly after the first of the year, if all things go well as they have to this point.

What food category would we find you within?

Several--well, we're not at liberty to give exactly where that one is going to go in the beginning. Let's just say generically it's probably in the bakery product area or in some processed foods area.

One of the--this is Steve. One of the advantages of the FiberRite compared to our Fibersym is it does open up some new opportunities for us in the processed and prepared foods area--or FiberRite rather. Whereas, Fibersym has [inaudible-multiple speakers] for the most part been relegated to the bakery area. So that's one of the reasons for our excitement about this particular new ingredient.

FiberRite gets more into the sauces than some of the liquid products.

Yes.

Okay. And on Chewtex, it sounds like you've got some new innovations and customers. And you make reference to it just beginning to hit store shelves. Where could I find it?

You can find some of the Chewtex resin finished products in Petco, big box retailers, such as Wal-Mart, those kinds of areas.

What brand would I find it under?

That I cannot share. I apologize.

Okay. And these are new and incremental customers, obviously.

That's correct. Just look for the ones that have the least amount on the shelves, that are flying off the shelves. Those would be our products.

Of course.

Of course. Right. And one more question.

Okay.

SG&A. What's the--I mean, anything abnormal within the quarter for SG&A - 4.8 million?

We saw some reduction in some of our incentive plans and IT costs. As we've talked before about our ERP program, we had some higher costs in the year ago quarter.

Okay. And full year fiscal 2006 you did 23.8 million, or realized 23.8 million SG&A. Is it safe to assume you'd be below that for fiscal 2007?

Yes. I think we will be below that for the year. Some of that is depending on some of the incentive plans that we have and how the year turns out. But on a normal year, we should be below that.

We've also done some rightsizing, obviously, as we talked about in the last conference call, specific to the ingredients area. And some of those reductions are showing up in the SG&A also.

Yes.

Okay. And as far as wheat gluten for the quarter, I mean, what's going on there from a pricing standpoint? And what percentage of business was it for you in the quarter?

The wheat gluten market is strengthening overall on a global basis. And that's from two major supporting global macro issues. The first is obviously last year in '06, calendar '06--or calendar '05 and into calendar '06, Australia brought in about a third of all of the gluten that came into the United States. Australia's had a wheat crop failure this year. I think last year they--.

--Because of the severe drought.

--Yes. Because of the severe drought. I think last year they produced almost 25 million metric tons, and this year they are forecast for 9 million. So we started seeing some reductions in gluten coming from Europe--or from Australia. We've also seen reductions coming from Europe, in part because of the change in the sugar regime, which gave artificially high prices on the sugar side of the business, which allowed the gluten to be dumped over here at below our cost value.

So because the sugar price has now been equalized with world prices in the EU, we've seen some of the big wheat mills slow down and there's less gluten coming this direction. So what we've started to see is gluten price up slightly compared to a year ago. We're starting to look really hard at volumes and where we need to place that. We're also, remember, always consuming our own production internally as the Chewtex line starts to grow again and the resins.

We also have to remember that wheat prices are up. So, in terms of a margin perspective, even with the increased--the beginning increase in the sales price of gluten, the margins are not dramatically improved at this point because of wheat prices.

And we're looking at this as probably a one-year anomaly.

In terms of the gluten price. Correct.

Okay. Within the ingredients segment, what aspect of the turnaround is going to be the largest contributor? Is it a given product--and contributor in the sense of getting you back to some level of operating margin contribution?

I think it's going to come--I don't think there'll be a single segment or area that we can point to. I think it's going to be a combination of several of our significant initiatives. I think the first and most important one that we've seen so far that gave us the results from Q1, that really occurred about a quarter earlier than what we had originally forecasted when we had our last earnings call, were the operational improvements. And just the improved yields, the improved operational efficiencies, the improved cost controls.

And those fundamental building blocks are going to stay with us now as we go through the subsequent quarter, as we start really rationalizing our product lines, start working our price increases into the P&L and being able to see those effects and some of those things. So I really think it will be the combination of those two. And then, in the out quarters, it will be the benefits from the renewed focus, as we talked about earlier, on the customer facing focus that we have now on our sales side and with our applications and R&D efforts. So I really think it will be ultimately a combination of all three, but they will be occurring in those phases in that order.

Okay, perfect. Thanks, guys.

You're welcome. Thank you.

Thank you. Our next question comes from Jonathon Lichter of Sidoti and Company.

Hi, guys.

Good morning.

Hello, Jonathon.

Do you expect a positive revenue comparison for ingredients by the fourth quarter--in the fourth quarter?

Boy, that's--.

--That's a tough one.

That's a tough one, Jonathon. I'm not ready to--I don't know that I'm ready to say that yet. But we should be--.

--Jonathon, what--we have said we'll be at the rate of.

Yes, we should be running at the rate--because it's not about revenue at this point. It's really about margin. And so, until we can find the right mix on the sales side and the product side and the manufacturing cost side to get us back from a margin perspective where we would like, Jonathon, it's really hard to start saying we're just going to start driving top line on the revenue. So I can't really answer that. I should be able to be a little bit closer by the next time we have our call. And a lot of that, too, remember, is going to be driven by our pet side and how fast we can recover some of that lost volume.

Can you give any I guess more detail into that--into the pet side?

We--just kind of what we've talked about so far. I mean, there's not a lot of additional detail. We continue to work on moving up the value chain. Obviously, we started at zero and it's going to take some time to build some critical mass there and get those volumes up anywhere comparable to what we had before when we were just making resins. We made--when you talk about resins, that's a million pound a month capacity or business. And these--certainly, when you're moving up the value chain in more value-added products, aren't anywhere near those kinds of volumes. So it's just really, really hard to predict how fast these things will take off. We are running at capacity, which is the good news. And we'll continue to look at every opportunity we can to increase that.

Does the fact that you're selling less--or less wheat gluten mean that you'd have to buy more corn for the distillery division, at least temporarily?

Not necessarily. It kind of depends on what our starch recovery rates are and the efficiencies that we are working on. But even that notwithstanding, Jonathon, you're still going to be dividing the starch contents by the prices. We're still better of buying corn, even at these numbers. So we still are not going to run the wheat plant to pass the wheat starch over into the alcohol division.

No. It doesn't make any sense.

And I don't think it would be a significant change from, say, a comparison to a year ago.

Okay. And I know in the past you didn't--I don't think you did any wheat hedging. Is there any--are there any plans for that?

We practice the same kind of--and I'll let Brian expand on that a little bit. But we--risk management is risk management. When we have sales contracts, we also hedge the raw material even on the wheat side. Brian?

Yes. We continue to do that. We have done less wheat in the last few years on a hedging program with futures. We typically with the area--more of our hedges is cash ownership of what we do. So we probably own more cash and wheat than we do with either futures or options.

But it's covered one way or the other.

I guess for how many months out do you have inventory?

Typically--it will vary, but typically, 60 to 90 days out for wheat inventory.

Okay. Thank you.

You're welcome.

Thanks, Jonathon.

Thank you. Our next question is coming from [Erica Mack] of Oppenheimer.

Good morning, gentlemen. My question has already been asked. Thank you.

Okay.

Thank you, Erica.

Thank you. Our next question is coming from Brian Freckmann of Crown Capital.

Hey, guys. How are you?

Great. How are you?

Good. So, guys, on your--I guess your fourth quarter June call you talked about obviously being hedged out till the end of the year. And then, we're mid-November and you guys sort of just said sort of end of calendar year. It sounds like from the other questions, you're really hedged out about six months. And yet, in your press release you just sort of talk about the second half of the year could be affected by fluctuations in fuel alcohol prices.

I guess I'm trying to understand. It seems like you probably will have a better in the first--I guess into the March quarter than maybe you're leading on? And I guess, on that note, I'm sort of curious on the distillery side, it looks like obviously the numbers were down just a tad from your June quarter. And given where ethanol prices are currently, it probably looks like December will be below September. And given where corn price is, and given that your--let's say your pre-tax numbers in distillery were down from the fourth quarter about 600 basis points, I'm kind of assuming that the margins should be down in the December quarter as well.

Is that--am I wrong to think that those are sort of just--I mean, nothing you can do--but just trends in general?

This is Tim. And I guess we'll try to take that. That's a multiple part question. So we'll try to address those.

Part of that answer is probably for Tim to answer and part of it will be for Brian to answer on the financial number part of it.

Okay.

I think when we had our fourth quarter call - and again, this is something that we continue to try to be as clear as we can - when we talked about our total coverage for the year, we talked about being hedged. But again, as we said again--earlier in this call, every out quarter that you go is less and less coverage because that's the nature of contracting and that's the nature of risk management. So when we said on the first of this fiscal year we had X% covered, we had X% covered. That was obviously a higher percentage in Q1, a little less in Q2, less in Q3, and less in Q4.

So the majority of our pricing risk, both on the sales side and on the raw materials side, rests out in Q3 and Q4, that's true. When you talked about the December ethanol price and the September ethanol price, I'm not sure I necessarily agree. What we really saw was a considerable decline throughout Q1 on spot ethanol prices. Again, if you go to the CBOT ethanol futures, you can see that. And recently, we've seen a rebound. And really, the rebound has come back to fairly similar values when we did some of our contracting that we're been working through in Q4 and Q1 and we will have in Q2. So I don't know that necessarily--now that changes all of the time, of course. But I--at least so far, it looks like ethanol had hits its bottom during Q1 and is starting to strengthen again.

And then, on corn though, I mean, I guess it appears maybe the top line seems--as you guys sort of hedge out. But it sort of sounded like--and I guess I was incorrect in thinking that you had hedged out each quarter. And to an extent, you have. But obviously, considering your distillery pre-tax margins were down from the fourth quarter 600 basis points, I assumed that just the price of corn and how that's been going up should continue to affect the margins there. Is that not incorrect or--?

Right. No, that is correct on the portion that's not hedged, that certainly will affect margins as corn prices go up. So--.

--I guess the last question is really, it seems that Wall Street actually is expecting your numbers - sales and EPS - to actually trend up to flat. And I guess I'm trying to understand it. Given where the commodity is, both ethanol and corn, it just doesn't seem as if you guys can--are going to generate positive or I guess growth next quarter, and especially on the bottom line, how that's going to grow, just given where corn prices are. Is there a reason that I'm sort of missing that Wall Street thinks that your EPS numbers should actually be going up? Or is it--I mean, is it certainly possible still or what am I missing here?

Well, I mean, I guess there's--corn is where corn is today. But just if you go--if you rewind 60 days, corn was $0.70 less. There's an extreme amount of volatility on the raw materials side, and maybe that's some of the thought process. It's certainly some of our thought process as we look out. I think on the ethanol sales side, it's really the same kind of thing. You get ethanol values where we had it during the summertime, even at 3.30 corn or 3.40 corn, there's some pretty good margins in there for sure from an historic basis.

How about just--if we just took a snapshot right today, and said that let's say the numbers didn't change from today. Would your numbers be up? I guess is the easiest way to do it, since we all sort of can see what today's number is. Would your distillery sales revenues be better or worse, and would the profits be better or worse than let's say this most recent September quarter?

The other side that maybe is a little different from--in our business is--and we haven't talked about, is the high quality alcohol side, the amount of business that we do in that area outside the fuel ethanol. And we see those prices strengthening going forward, too. So there's another--.

[Multiple speakers.]

--By the end of the year. So that's--.

--But generally, I mean, you're right that if input costs go up and sales prices don't move up with them, the margins are going to go down further out if the trend in corn and ethanol would stay where they're at today.

Okay. And then, on the--back to the--as you guys mentioned just recently, on the food grade side, you've seen--you say a price increase in the June quarter. Has that--are you still seeing price increases there or has that sort of leveled off because it had such a giant increase? I think because it moved from synthetic to what you guys are producing.

Well, we're continuing to see price increases and strength in the marketplace on the sales side and the pricing side due to continued carryover from the exit of synthetic, just increased demand overall for those products, but also as a result of the increased corn prices. We are able to pass some of that on in price increases.

Okay, guys. Thank you. I'll just jump back in queue.

You're welcome.

Thank you. (Operator Instructions.) Our next question comes from [Marcello Bazo] of [Triatta].

Hi, there. My question's been answered. Thanks.

Okay. Very good.

(Operator Instructions.) There appear to be no questions at this time. I would like to turn the floor back over to Mr. Seaberg for any closing remarks.

Okay. Let me close by saying that we're very excited about our future prospects. Thank you again for joining us this morning and we look forward to talking with you again when we report our second quarter earnings. And this certainly concludes our call at this time. Thank you very much.

Thank you. This concludes today's MGP Ingredients Conference Call. You may disconnect your lines at this time and have a wonderful day.