MGP Ingredients Inc (MGPI) 2007 Q4 法說會逐字稿

Good morning. My name is Jason and I will be your conference operator today. At this time, I would like to welcome everyone to the MGP Ingredients Incorporated fiscal 2007 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)

Thank you. It is now my pleasure to turn the floor over to your speakers, Mr. Ladd Seaberg, Chairman and CEO, and Mr. Tim Newkirk, President and COO. Gentlemen, you may begin your conference.

Good morning, everyone, and thank you for joining us on this conference call to discuss our fiscal 2007 results fourth-quarter results. With me today on today's call are president Tim Newkirk; Brian Cahill, Chief Financial Officer; and Steve Pickman, who is Vice President of Corporate Relations.

I will begin with a brief review of our fourth-quarter performance. Brian will provide more details on our financials. We will then turn it over to Tim for updates on operations. After that, we will open up the call for any questions that you might have.

As you see from our results, our top-line growth has continued to be driven by our distillery segment. During the past quarter, we again achieved higher alcohol throughput, while each of our principal distillery product categories, food-grade and fuel-grade, benefited from improved selling prices compared to a year ago. However, whereas pricing in the food-grade alcohol area has remained on a steady course, fuel-grade alcohol pricing has been volatile over this past fiscal year, with spot prices reaching new highs in the first quarter, only then to decline around 12% from those peak levels by the end of the year.

While our distillery segment margins have good long-term potential, profits were squeezed this past quarter by a rapid spike in corn prices, which averaged nearly 76% higher compared to a year ago. For the first half of the current fiscal year we were hedged for approximately 50% of our anticipated corn needs, (inaudible) taken to reduce our exposure to price volatility.

Let me now briefly talk about our integrated ingredients segment. We have one major goal over the past year that was to return this business to profitability. Let me remind you that this was no small feat when you consider the loss of sales to our major pet treat customer and higher wheat costs. We finished the quarter with a 19% increase in total ingredients sales, and it was very gratifying to see positive results on the pre-tax income line.

We mentioned in our news release that sales of vital wheat gluten contributed to the strong quarter. By the way, increased customer interest in our gluten began occurring before the discovery of chemically tainted imports in Chinese wheat flour disguised as gluten pushed [demand] even higher toward the end of the fiscal year. Following many years of the stressed gluten pricing, the fundamentals turned positive this past year, as reflected in improved selling prices. We responded to market needs by quickly ramping up our gluten capacity. Along with a new demand created by the Chinese scare, we expected to run higher production levels during the current fiscal year compared to fiscal 2007. For those of you who are new to our story, MGP Ingredients has the largest solid vital wheat gluten capacity in the United States.

Tim Newkirk will talk more about the profit improvement in our ingredients segment and the benefits we expect going forward. First, I will turn the call over to Brian Cahill for a review of financial highlights. Brian?

Thank you, Ladd. As reported in today's news release, our fiscal 2007 fourth-quarter net income was $1.7 million, or $0.10 in diluted earnings per share. For the prior year's fourth quarter, we had net income of $7.4 million or $0.43 in diluted earnings per share.

Net sales for the final quarter of 2007 were $101.5 million compared to sales of $90.3 million in the fourth quarter of fiscal 2006. While our sales experienced a sizable increase, the significantly higher grain prices, particularly corn, that Ladd mentioned were a key factor in preventing our fiscal 2007 fourth-quarter earnings from being more favorable.

Despite the impact of increased grain costs, we completed fiscal 2007 with record net income of $17.7 million, or $1.05 in diluted earnings per share, on record sales of $368 million. Our net income in fiscal 2006 was $14 million, or $0.83 in diluted earnings per share, on sales of $322.5 million.

Our profitability for the year was driven by our distillery segment, which had pre-tax income of $38.8 million, an increase of $1.8 million over fiscal 2006. Our ingredients segment in fiscal 2007 had a pre-tax loss of $9.5 million, which was $2.3 million better than the pre-tax loss of $11.8 million that we had the prior year. Most noteworthy is that after several consecutive negative quarters in this segment, we experienced a turnaround in the 2007 fourth quarter, showing a pre-tax profit of $607,000. Obviously, that is a huge turnaround compared to the $7.2 million loss that we experienced in fiscal 2006 fourth quarter.

Our cash flows from operations in fiscal 2007 amounted to $14.7 million. Capital expenditures for the year were approximately $23 million, with about 48% related to previously committed environmental compliance and energy efficiency improvement projects. For the current fiscal year, we are projecting capital expenditures in the range of $10 million to $15 million.

That completes my financial overview. Let me now turn the call over to Tim Newkirk for an update on operations.

Thanks, Brian. This past fiscal year was all about execution. On the distillery side, we set out to increase our annual production volumes by adding new capacity, changing some of our manufacturing processes, and reconfiguring some of our plant assets. The near-term target from our capital investments is to realize a 15% increase in our total productive capacity by the end of the summer. We believe we got about halfway there over this past fiscal year.

Equally as important as adding new physical capacity, our manufacturing employees really rose to the challenge by hitting several monthly production records. We are finding smarter ways to make products. We also opened up capacity by debottlenecking certain areas of our plant network. In both cases, we are improving MGP's fixed asset turnover, a key to generating more cash and improving the Company's return on investment.

Regardless of our near-term alcohol sales mix, we want to be among the most efficient producers of high-quality alcohol. Part of this will come from reducing our energy costs. We saw some relief in this area during the past fiscal year compared to fiscal 2006, due largely to lower natural gas prices. For a longer-term solution, we are exploring alternative energy sources, some of which may require capital investment.

Let me say a few words about our outlook for ethanol and explain strategy as it fits into MGP's long-term vision. Clearly, fuel-grade alcohol has enjoyed unprecedented growth and profitability for the alternative fuels industry over the past few years. While industrywide fuel-grade ethanol expansion continues as strong as ever, margins are returning to more traditional levels. We expect continued volatility in fuel-grade ethanol margins, and as a result, remain focused on continuing to build on our historically strong position as a premier producer of food-grade alcohol. This has been our focus for more than 65 years and will continue to be a focus in our future.

I would like to wrap up my formal comments with a few words on the transformation taking place at MGP Ingredients. You see from our financial results that we reported a record year in sales and profits. What you do not see are many of the things behind the scenes we accomplished that will have lasting benefits.

To name a few -- we restructured our ingredients segment and produced an operating profit in the fourth quarter. We streamlined our ingredients portfolio and improved the overall mix and pricing of our products. Our new Technical Innovation Center brings together R&D and applications support to engage customers in ways never before possible.

We made several key new management hires in the areas of product innovation, purchasing and supply chain, finance and accounting, and extrusion technology. And our compensation programs going forward will include measures that track and reward the creation of positive economic value.

Someone told me a while back that MGPI was a show-me story. We took this to heart when we introduced a plan to drive peak performance across the organization last year. We put the challenge out to our employees and said, "show me." As you can see, the early results are gratifying and our future prospects look promising.

With that, I would like to turn the call back over to Ladd.

Thanks, Tim. That concludes our prepared remarks. Before taking any 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. Now with that, we are ready to open the line for any questions that you might have.

(OPERATOR INSTRUCTIONS) Tony Brenner, Roth Capital Partners.

I have two questions. First of all, I wonder if you can tell us what sort of profit margins there are on the vital wheat gluten business and what part European imports are playing in that sector at the moment.

This is Tim. We do not disclose profit margins on vital weak gluten for a couple reasons, the first of which being it is part -- one of the coproducts of the many different products we have as we produce the protein and starch and process the wheat flour. So it is very hard for us to look at that specific product and get a specific margin.

But let's just say with the -- the failed wheat crop we had a year ago in Australia was really kind of the beginning. Actually, it was failing about this time a year ago. It was really the beginning of seeing gluten prices starting to increase. So as we rolled out of contracts last December and into contracts going forward through our Q3 and Q4 that we're reporting on today, we had already had in place new sales at much higher prices than what we had seen on the income statement over the last couple of years.

One of the things that we are noticing and what's really driving that, quite frankly, is just an overall increased demand globally for vital wheat gluten. A large portion of the European vital wheat gluten goes into the fish meal feed in Europe itself, and that demand has increased. So we have seen a slight reduction in European imports because they are satisfying demand reticent there in the EU.

And then, of course, we know about what happened towards the end of our last third quarter, beginning of this fourth quarter, with the Chinese wheat gluten issue and the pet food recalls. So there has been quite an increase in demand domestically, and as we talked about in the last earnings call, we were going to do everything we could to rise to the occasion and supply the market demand, and that would start being accretive really here in this first quarter of this new fiscal year, not too much in that fourth quarter.

Most of what we saw in the fourth quarter, Tony, really came as a result of just the natural demand increase and price increases that we had already occurring from more what I would call typical market factors.

Tony, this is Ladd speaking. Everything Tim says is very true. I guess you could say it is fair to say that new gluten sales are profitable.

Okay, that's fair. Thank you. My second question is that in your release, there is the implication that you will be more aggressive in hedging activities, particularly for grain. I wonder if you could embellish that statement a little bit.

This is Brian, Tony. I don't know if we are going to be more aggressive. We're just going to continue to look at opportunities to hedge grain and hedge margin. Obviously, after coming -- high prices of grain in the June period coming down, we have taken some positions as the market came down. And the corn price now has dropped over $1 a bushel from the high towards the end of June.

So we are looking at opportunities where we can lock margin and also, even if we do not have the sales booked going out forward, if we can lock in a good input cost --.

You have always done that. This sentence in the release suggesting you are strengthening that function with the aim of reducing the effects implies that you'll be doing something different. Is that not true?

Well, I think we're definitely taking a harder look at that. We're also looking at, even as Tim mentioned on the energy side, maybe trying to take some of the volatility out of natural gas by looking at coal going forward. But yes, we are looking at anything we can do to minimize the volatility of corn natural gas and the selling price of ethanol.

I think, Tony, you've heard us talk about -- this is Tim again -- quarter after quarter about continuing to try to strengthen our disciplines in that area and our competencies in that area. That I think is what that sentence is really speaking to. Some of the recent hires that we have are bringing some very strong risk management competencies to the table that are helping us think about the way that we approach risk management.

Also again, with the increased volatility in corn, we had better be stepping up our efforts in this area. Because obviously we have seen volatility at greater rates than we have ever seen, both on the energy side and on the input side. Let's talk about wheat. We are pennies away from all-time record highs in wheat on the CBOT. So yes, we had better be stepping it up, and we wanted to make sure people understood that we recognize that increased volatility and we're going to position ourselves to deal with it.

Thank you.

Jonathan Lichter, Sidoti & Company.

Are you still sticking with that goal of tripling production of weak gluten?

Yes, we talked about that in the third-quarter call and, in fact, that is -- from previous or historic levels, that is still absolutely where we believe the market will be. You know, quite honestly, from the way that -- as the market responds and as the market provides us opportunities to get a fair return for the installed capacity, we're going to continue to look at that and exploit every one of those opportunities.

So to try to give some indication, at a minimum, I think that is a very safe number. But that is not to say that if the market does not continue to strengthen and continue to provide MGP with opportunities for fair return, that number could not get greater. It is also not to say that if the market goes the other direction, we would not back it off again. So we're just going to kind of watch and wait and see what the market provides for us.

What kind of timeframe do you think you could reach that goal in?

We're already operating at those levels. As we indicated in that third-quarter call, by the time we hit Q1 of FY '08, we would be at those rates, and in fact we are.

How much of -- since you cannot, I guess, give the actual margin -- how much of the increase in the ingredients margin came from -- what percentage came from the higher wheat gluten prices?

I am not sure. There is a lot of movement, a lot of different things moving in the ingredients side, Jonathan. It is not real easy to give just a number attributable to gluten, because we've got higher throughput rates, which are changing fixed costs across the entire product portfolio. We've had other good improvements going on. So I could not give you a real good representation of what effect that would have.

The only comment I want to make sure that is clear is that the majority of the effect from vital wheat gluten in the fourth quarter were from decisions made pre the pet food recall and the corresponding opportunity that we have from that. Those will not be starting to come into the income statement until this first quarter of this year.

Okay. And on the distillery side, can you give a little indication as to where you think margins could get back to -- how high can they go following this quarter?

Well, can't give you specifics, but just generally what the market is doing, corn prices have fallen in this quarter and the new crop potential looks pretty good. USDA's carryout is about $1.5 billion, and the new crop futures prices are in the -- right around $3.40, versus, I think, the average in the fourth quarter was about $3.75 in that period. Going all the way up to about $4.30.

So we are seeing lower input costs there. Natural gas, we're seeing lower input costs there.

The other side of it, though, is on the ethanol pricing for the fuel side, we're seeing lower pricing on the Chicago Board of Trade ethanol market. However we still continue to -- as we've talked about -- continue to really try to continue to grow our high-quality alcohol market. We're seeing good, stable pricing there. So we're seeing improvements. To give you an exact figure, it is kind of a moving target with the lower input costs, but then lower ethanol pricing.

Also, just can you tell me what that other operating income line, the -- it was $858,000 -- what that is composed of?

Yes, the majority of that relates to some service activities that we do along, with a program that we had where we recognized income from the commodity credit program going back several years.

At what level would you expect that to continue?

Somewhat similar level going forward.

The commodity program?

That will last about another six years, I believe.

And the service activities?

That probably will stabilize at about where it is, maybe a slight reduction from the numbers there. But should be fairly consistent.

Okay, thank you.

Steve Denault, Northland Securities.

What -- the corporate expense or the SG&A was actually quite low in the quarter. How do I interpret that?

Versus prior year?

For instance, the corporate expense was, I think, $34,000. Prior year, it was $2.3 million.

Okay, some of that is related to incentive programs that we have got for the year. And that is a primary reduction. We had some interest income in there. That is probably the biggest reduction.

What is a good way to think about SG&A going forward?

Going forward, probably, if you take the 12 months to date, would probably be a good quarterly number -- the fiscal 2007.

Okay. As you head into this first quarter, how does your hedging look in terms of percent of input costs as it relates to wheat and corn and percent sold via contracts of ethanol?

For the first quarter that we are in right now, as we have stated, we've got over 50% basically locked in for both the input cost, probably more than that on the natural gas, since we are halfway through the quarter. Basically, most of our ethanol at this point is locked up too.

Is the ethanol locked up at prices comparable to the fourth quarter?

Yes, I would say on the high-quality side, yes. The fuel side, what was contracted, yes. And the spot market has come down.

Okay, what -- of the 50% of the corn you've got hedged, at what levels do you have your hedges at?

Well, we've got them at levels all the way through the period of as the markets come down, we've done hedging as it has come down. Today, the market is -- the new crop is getting close to the low. I think we've seen $3.30 on the futures. So we have been averaging as the market has been coming down.

So maybe averaging $3.50 on that, what is --?

Without a specific number, maybe in that area, maybe slightly above that.

Okay. The vital wheat gluten sounds like it will be at a 60 million pound run rate -- is that correct -- in the first quarter?

I would say that is a reasonable approximation.

Is that towards the tail end of it or, like today, it is at that level?

That's a good question. It is going to kind of depend on how fast and how quickly some of the demand from the pet food side recovers. We have got contracts in place that balance against that approximate level that you're talking about. We've seen a little bit slower pull on the demand side. Some of those customers did not get -- have not seen the business rebound as quickly as they had contracted for and anticipated.

So I would say for sure by the end of the first quarter, we will be there beginning of the second quarter. That is probably pretty fair.

Okay. And what kind of levels were you at in terms of vital what gluten pounds sold in the fourth quarter?

Somewhere less than the approximated number that you had.

Okay. How has the pricing trended lately on that, in terms of just the vital wheat gluten price?

Prices are up dramatically over year-ago levels. They are up -- when we rolled out of contracts -- we talked about it, I think, in the third quarter. We had rolled out of $0.50 a pound contracts in January of '07, and that kind of had been historically where that market was for probably the six to twelve months preceding that. And we replaced those at numbers quite a bit higher.

When we think about where we are versus even a year ago, we're probably at least 50% higher than we were a year ago. Remember, there's some offsets to that. Obviously, wheat has gone up dramatically. But having the gluten price up 50% is always a good thing.

Right. And so there's probably good reason to believe that that $0.75, $0.80 level would carry forward for the balance of the year, calendar year?

I would sure hope so. Again, it is one of those things, as we've talked about for several years -- and the entire reason that we've been focusing on optimizing our product mix and driving sales through the target products and ingredients and working on that entire diversification -- because of global economics, we are not in control of our destiny on gluten pricing.

So I cannot -- it is very hard for us to say where things are going to go. To sit here and talk about in one year a price of a commodity type product up 50% is an incredible statement to make in an of itself. So it is hard to talk about what things might look like as we go forward. It kind of depends on what the Europeans do. It depends on demand.

I will tell you that on a global basis, demand for protein is up -- protein prices, regardless of whether it is animal protein or vegetable protein -- any kind of protein are going up at dramatic rates. We feel pretty good about it, but that could certainly change.

And again, remember, for us, it is about the specialty ingredients primarily. We're not taking our eye off that ball. We're going to continue to work on optimizing our sales mix and continuing to work to drive growth and drive value delivery to our customers and our partners through those specialty ingredients.

All right. Thanks a lot.

Robert Simmons, Oppenheimer.

You said that your gluten production was pretty much up to your capacity, right?

No. We said to that three times the rate we had been running before, not to capacity.

Okay, so what was the actual number during the quarter?

We're not going to provide that.

Okay, that's fine. Do you have any updates on the lawsuit with Mars?

Not really past what was the public filing from the Markman case. That is one more step in the process. In an IP case like this one is, you have to go through what is called the Markman process, where the definitions used in the patent are basically argued about and litigated and the judge makes a decision. And the judges ruling is there for public information.

But let's just say that the definitions that we had in the original patent are the ones that were upheld by the judge. And so it is just one more step down a long, along road, and we're going to continue --.

It looks very good at this point, but it is not over until it is over.

Exactly.

All right, thank you very much.

(OPERATOR INSTRUCTIONS) [Corey Johnson], [Kingsford].

Good job on the SG&A. I thought you were going to attribute it to good old Midwestern values. But did you say that there was interest income in SG&A, or did I hear that wrong?

No, not in SG&A -- in other income.

Okay. I did hear wrong, my apologies. I will then return to attributing that to good old Midwestern values.

Thanks. We will take that.

You talked about kind of pernicious ethanol margins. Could you explain what is happening there? We all know what is going on with corn prices, but maybe you could talk a little bit more about what's happening in that business.

I guess there's two sides of our business on that, which our real focus is in the high-quality market and continuing to try to develop good, long-term relationships there. We see that market being stable and margins continue to be good in that area.

The other area is the fuel market, which there's a lot of press out there with the increased capacity coming online in that market. We are seeing -- generally, over the history in that market, we will see ethanol trade above gasoline, the rebound market; and currently it is below that market. I think it is just selling price. There's supply and demand and there's plenty of supply of ethanol out there.

So compared to a year ago, where we saw just a very tight market, I think the market is well-balanced right now, and there is just a discount to gasoline. Which in the long-term should really improve demand, because there's a lot of margin opportunity for the blenders, plus some of the additional things that are longer-term that will increase demand for that product.

But just to be clear, so what you are seeing right now is a lot more production online, and that's pushing prices down.

Yes, we're seeing a lot of new production coming online. I guess the other thing that we are starting to see is some of the projects that were -- all the development when the margins became so good last year or the last couple of years, there's been a lot of new capacity that has either come online or coming -- plans for financing.

We are starting to see a little pullback in that area, with some projects either on hold or maybe not getting the finance that they need. But we're just in one of those periods now where there is new supply coming on the market and the market needs to absorb those gallons.

How long is that going to take? How bad could this get before it turns around? I mean industrywide, not just for you.

Yes, that is a hard one to answer. One of the things that happens, there is infrastructure that has to come into play too. You know, how to blend the ethanol; there's railroads that need to move the alcohol. But it is very difficult to say. I guess the one thing that is positive for demand is at current pricing, there is a lot of margin opportunity for people to use ethanol.

Thank you. Let me ask -- also on the pet food business, I guess my fundamental question, are you seeing the pet food recall business that you had predicted? You talked about it last quarter, but you didn't see any of the business in the quarter that you were reporting. Are you seeing it at all? Is it at all possible that you will not get this business or is it a lead pipe cinch? Is it a certainty?

We have contracted -- provided that the sales are there, we have contracts in place. It is going to be -- there's always different contract terms and overages and underages for allotments against contracted volumes. So outside of those caveats, the run rates that we expect to run at, we expect to run at. The sales look strong. Demand looks strong.

Again, I want to make sure we are clear -- fundamentally, the vital wheat gluten market in the U.S. is very strong because of a lot of global things. This year's wheat crop in the U.S. was -- hard red winter wheat crop was less than desired. The proteins are low. That historically, for the 40 years we've been making gluten, has always been very positive for gluten demand in the U.S. We lost a considerable chunk of supply with the Chinese problem that was out there and is well-documented in the public arena. And then Europe has a dramatically lower crop and lower in quality and lower in quality than what we even knew about in the third-quarter conference call.

So again, I think fundamental demand is strong, and I do not want to leave people with the impression it is just completely attributable to the pet food recall issue. Because obviously you're right -- there are some inherent risks in that pet food recall, new business coming our direction and whether demand gets back up in those areas. I can tell you that so far, our customers are pulling at expected rates, so --.

But it is a very dynamic environment and we are just kind of -- hopefully by the end of that first -- when we report first quarter, we'll have a pretty good indication on where we're going for the next year, anyway.

Yes, because we all know the 40-year history, but the difference -- there's a big difference right now, that being China. And it's sort of the wild card right here.

Yes. The only thing I might caveat, though, or add to that thought -- again, prices had come up dramatically even before that. And demand was growing; supply was not keeping pace with demand. Even before the reduction in -- or the issue that we had with the Chinese protein coming in, and then, obviously, it not being in the market today.

So I think things look really strong, and we will have to kind of watch. It is a big difference. But again, I am very pleased that we were able to help out in this unfortunate situation, but demand was strong and pricing was up regardless. And a lot of that was driven by the price increases in wheat over the last couple of years, the failed crops and some of those basic fundamentals in the industry that would have been there regardless and would have helped us out regardless.

Greats. Thanks a lot.

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

Okay. Even though MGP Ingredients has a history dating back over 65 years, to a certain extent, this past year represented a new start. We continue to enjoy our long-standing customer relationships and unique capabilities. What is new is a stronger business foundation, a greater emphasis on growth and added measures to ensure we created stockholder value.

I want to thank you for joining us this morning and we look forward to talking with you again when we report our first-quarter earnings. This concludes our call at this point.

Thank you. This concludes today's MGP Ingredients Incorporated fiscal 2007 earnings conference call. You may now disconnect your lines and have a wonderful day.