MGP Ingredients Inc (MGPI) 2008 Q2 法說會逐字稿

Good morning. At this time, I would like to welcome everyone to the MGP Ingredients fiscal 2008 second quarter earnings release 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 host, Ladd Seaberg. Sir, you may begin.

Good morning, everyone, and thank you for joining us on this conference call to discuss our fiscal 2008 second quarter results. With me on today's call are Tim Newkirk, President and Chief Operating Officer; Robert Zonneveld, Chief Financial Officer; Brian Cahill, Executive Vice President of our Distillery Products business; and Steve Pickman, who is Vice President of Corporate Relations.

I will begin with a quick overview of our second quarter. As we reported today, our fiscal 2008 second quarter net income was $5.3 million or $0.31 in diluted earnings per share. This compares with net income a year ago of $6.8 million or $0.40 in diluted earnings per share. These results included a $7 million gain on a settlement of litigation, net of related expenses without which the Company would have reported a loss before taxes of $2 million. I want to point out that our second quarter loss included inventory write-downs of more than $1.3 million as well as losses related to our products and development in pet and plant-based biopolymer applications.

Our total sales for the quarter were 7% higher than last year's second quarter, in spite of dramatically reduced fuel ethanol prices. However, the lower ethanol prices and higher grain prices, specifically corn and wheat, were key factors in adversely affecting our bottom line.

The bright spot in the quarter was the progress we are making in building sales, especially starches and proteins in our Ingredients Solutions segment, particularly in the face of higher wheat costs. As planned, we achieved higher sales of our food grade alcohol products during this past quarter. We expanded selling efforts we aimed to continue to increase our market reach in this area, both for beverage and industrial applications.

In summary, as I stated in today's news release, we continue to experience earnings volatility on the fuel alcohol side of our business. We are encouraged by the recent firming of prices. At the same time, our food grade alcohol products remain a very solid contributor to our bottom line.

In December, we settled our two-year patent infringement and contract litigation for $8 million. During the first and second quarters of this year, we incurred professional fees of $954,000 related to this litigation. We settled this amount.

Next, we'll turn this over to Robert Zonneveld, our CFO, for a review of financial highlights.

Thank you, Ladd. Now I will give you some financial highlights on the income statement and balance sheet, focusing on our results for the first six months of fiscal 2008.

In our Ingredients Solutions segment, our year-to-date sales increased by $18 million or 62% compared to the prior year. Our gross profit in this segment went from a loss of $670,000 to a gross profit of $5.5 million for a year-over-year positive turnaround of $6.1 million. Our current year results also included $938,000 inventory write-down to bring the inventory value down to net realizable value.

Sales revenue for our Special Ingredients, which are primarily special proteins and starches, increased by $6 million or 28%. This reflects a successful execution of our strategy in this part of our business. Sales revenue for vital wheat gluten increased $12 million or 182%, which resulted in both increased sales volume as well as higher per unit pricing. While sales revenue for Ingredients Solutions improved dramatically overall, margins continued to be impacted by increased cost of sales related to record high wheat prices. The per bushel cost of wheat for the first six months increased by 36% compared to the prior year.

In our distillery products, our sales for the six months decreased by $8.8 million or 6% compared to the prior year. Our distillery gross profit went from a profit of $35 million to a gross profit of $5.8 million or a decrease of $29 million. The key drivers for our distillery businesses were reduced revenues for fuel grade alcohol of $14.5 million, due to reduced ethanol pricing, as well as reduced production levels related to fermentation problems, which we now believe have been resolved.

Consistent with our strategy, this decrease offset by increased revenue from our food grade alcohol of $4.3 million, which was a result of increased per unit pricing, partially offset by a slight decrease in unit sales.

In addition to reduced revenues for distillery products for the first six months, margins were significantly impacted by increase of cost of sales related to higher per bushel corn cost of 49% compared to last year at this time. This increased cost, along with reduced revenues, drove the reduced gross profit for the segment.

In our other segment, our sales for the six months were flat compared to last year. In our pet resin business, gross margins were impacted by an additional inventory write-down of $370,000, as this inventory is no longer a fit into our longer-term pet resin platform plan.

Our SG&A expenses for the year-to-date compared to last year increased by $1.1 million or 11%. This increase was primarily the result of higher compensation costs related to finance, IT, supply chain, and R&D staffing conditions as we continue to add the skill sets and competencies necessary to strengthen the Company's -- for our future growth capabilities. Also, higher costs related to occupancy costs associated with our new Technical Innovation Center and corporate office complex, as well as increased costs related to employee health care benefits. We anticipate SG&A expenses will continue throughout the remainder of the current fiscal year at approximately the same level experienced in the first six months of this year.

In December, we settled our two-year patent infringement and contract litigation for $8 million. During the first and second quarters of this year, we incurred professional fees of $954,000 related to this litigation. We had netted this amount against a settlement for a net amount of $7 million.

As of December 31, 2007, we had approximately $3 million in unused Kansas state income tax credits related to capital investments we have made at our Atchison facility. It was determined that the valuation allowance was no longer appropriate, as we've met all the requirements to earn the tax credits. This resulted in a tax benefit in the quarter of approximately $2 million. Our effective tax rate for the year-to-date is currently 34% compared to last year at 38%.

Looking at our balance sheet. The main driver of the balance sheet was inventory increase of $19 million since the beginning of the fiscal year. This increase was due to alcohol inventory increasing $5.7 million, due primarily to an increase of 5.6 million gallons from the beginning of the year. Our inventory is consistent with our desire to grow into the food grade alcohol area. It also matches our plans to capitalize on opportunities in the fuel grade alcohol market, where prices currently are averaging $0.24 a gallon higher than prices realized in the second quarter. Starch and protein inventory also increased by 12 million pounds or $3.5 million to support our sales initiatives going forward.

As a result of our input hedges being below current market prices, our market-to-market hedging adjustment to inventory was up $9.8 million. The adjustment was an increased inventory of $7.5 million versus a reduction in inventory of $2.3 million at the beginning of this fiscal year.

On February 6, 2008, we entered into an amendment to our credit line. The amendment increased the maximum amount available under the credit line from $20 million to $30 million. As of February 6, we have $12 million in outstanding borrowings under the line.

This completes my financial review. Now let me turn the call over to Tim Newkirk for his update.

Thanks, Robert. Understandably, we are not satisfied with our overall bottom-line results, which felt significant impact from the pressure of higher input costs. However, we are pleased with the continuing upward sales trend in our Specialty Ingredients area and the positive contributions that continue to be made by the food grade alcohol component of our business. Furthermore, we are excited and encouraged about a number of programs and initiatives that are underway and designed to provide greater opportunities to bolster our future profitability.

While we are seeing little relief in corn prices at this time, ethanol pricing has shown signs of strengthening. If prices do increase in the second half of the fiscal year, we are positioned to benefit with most of our ethanol capacity uncontracted. On the other hand, if ethanol pricing remains depressed, given that current corn prices are averaging more then $5 per bushel, we would not anticipate much of an improvement in our bottom-line results from this area of our business.

I want to emphasize that we remain very confident in the earnings power of our distillery operations. In spite of the lower ethanol prices and higher corn costs, we continue to show profitability in our Distillery segment, both in the second quarter and for the first six months of fiscal 2008. This speaks quite well of our ability and strategy to maintain our strong presence in the food grade alcohol arena. Our long-term strategy continues to be to maximize utilization of our high quality food grade alcohol capacity, and to improve our overall alcohol processing efficiencies.

Now I would like to talk about Ingredients Solutions, where our sales momentum continues to build. Along with higher quarterly sales, we showed sequential improvement over our first quarter in key product lines including our Fibersyn RW resistant starches as well as our Wheatex textured proteins. We still have further to go before reaching volume levels that will generate sustained profitability for this segment, but the product mix continues to shift in the right direction.

A key indicator of our progress is the improvement in our gross margin percentage, which went from a negative 2.3% a year ago to a positive 11.5%, despite the 36% rise in wheat raw material cost. This improvement reflects the success we are achieving in developing a higher value product mix.

Excluding the inventory write-downs we took in the second quarter, the Ingredients Solutions segment continues to track our plan for higher sales and improving year-over-year contributions to our bottom-line. Even with the much higher wheat prices and despite the impact of that inventory write-down, our second quarter pre-tax loss of $124,000 in this segment represented a significant improvement over the pre-tax loss of $2.8 million that we experienced in the same period one year ago. As a result, for the first six months of the current fiscal year, we were able to achieve a pre-tax profit of $187,000 in this segment versus a pre-tax loss of $5.2 million for the first six months of fiscal 2007. We are very encouraged by the collaborative efforts between our research and development, applications technology, and sales and marketing staffs to establish a more disciplined and effective commercialization process for targeted ingredient solution technologies.

Our scientist and application technologists additionally are involved in a number of new initiatives to improve product development and manufacturing process efficiencies. The aim of these initiatives essentially is to better serve our customers by employing better and smarter methods of utilizing existing assets to produce increased value. Already, we are seeing some very promising results.

Simultaneously, we are focusing efforts on providing our customers with a greater sense of the economic as well as functional value they can derive from our various and unique Ingredient Technologies. In other words, we are dedicated to delivering the whole solution to our customer partners.

As a reminder, we are still very early in the process of re-engaging our customers across a growing number of new opportunities. As I have already indicated, our new configuration of combining R&D and applications into a stronger customer-facing team is already paying off with an increasingly appealing product pipeline.

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

Thanks, Tim. That 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 cost our actual results and guidance to vary materially from expectations. Additional information about these factors can be found on 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 are now ready to open the line for any questions you might have.

(OPERATOR INSTRUCTIONS). Jonathan Lichter, Sidoti & Company.

A question about the loss in the Other segment. What was that related to and what do you expect for the remainder of the year there?

Jonathan, this is Tim. That loss is really coming from, as we indicated in the early remarks and in the press release I believe, the restructuring of the pet business as we transfer away from making ingredients to making more finished products. Those are lower volumes across the same basic large asset-base that we had in there when we were doing business by just simply making an ingredient. You've also got the beginning of the business of the biopolymers or the biodegradable plastics that we're working on at our Onaga, Kansas facility. And again, it's just low volumes spread across some already installed capacity.

So, as those businesses really gear up and we start seeing increasing top line results, you'll start seeing those losses reduce as profits fall to the bottom line, because we have the assets in place to run much larger businesses than we're seeing right now. So, as to how long those will -- we'll continue to see those, I would like to think within the next six months, we'll see -- we'll begin to see the improvements and the realization of some of our efforts that we're working on right now. That area of our business is one of our top priorities right now and a major focus for this leadership team to get those losses stemmed.

The loss was a lot more than it was in the September quarter. What was the difference between the two quarters?

You have a $350,000 -- approximate $350,000 inventory write-down to net realizable value for some of the older inventories that we had that were stemming from our original business that we were doing on the pet side, Jonathan. We've also got -- some of the different product mixes we were selling in that period of time also came to bear.

Okay. And in terms of -- you mentioned the large increase in the specialty area of the ingredients business. How much of that was price compared to volume?

We were -- I guess the way to think about that is we're probably -- for every unit increase that we have in revenue -- let's see, what's a good way to explain that? We've got -- both volumes and revenues are increasing. And revenues are increasing at a rate faster than volumes increasing. But I don't want to minimize the impact of the increases in volume, because those are quite substantial also.

And how successful were you at passing along price increases for 2008 in the ingredients sector?

How you define success is going to be the key there. But no company in the business that we're in, where we're taking a whole grain and doing the first set of unit operations on that to produce products, could ever possibly keep up on the pricing side when we've got the kind of volatility that we have right now in the wheat side of the business and even in the corn side of the business. So, we're always going to lag the market when it is volatile as it is. I mean, we've got lock limit up days on wheat for the last several days and we can't possibly keep up on the pricing side with that.

However, we are, as everybody in the country knows, with raw material prices where they are, we really have done a pretty good job getting some of it passed on. But we're going to be lagging several months anyway on the price increase. We've also got our hedging practices in place, which help mitigate this a little bit. But we're doing the best that we can with that, but it's never going to be fast enough.

What are the prices that you've hedged corn at?

We won't get into exact prices. And I'll let Brian talk about kind of the percents, because I'm sure that's going to be a question a little later.

Yes, Jonathan, this is Brian. At the end of our second quarter, we had approximately 75% of our corn needs hedged and purchased through the end of the fiscal year. And on the wheat side, approximately 25% through the end of the fiscal year was hedged and purchased at the end of the second quarter.

Okay. And then last question. You mentioned that there wouldn't be much improvement if there's no change in ethanol prices. Is that from today's price or from the end of the second quarter? What are you comparing it to there?

If we don't see significant -- well, given -- it was two parts to that. Given raw material prices being where they are, if we don't see -- if we can't hold the current pricing on ethanol or don't see improvements, then we're going to continue to face some substantial headwinds and see an increased profitability there. So that's what we were trying to say.

At some point, everybody's hedges begin to run out. And if you look forward in the Chicago Board of Trade corn futures market, you can't find anything less then 5.25 probably all the way out through 2009. And so, everybody knows the conversions. If you figure you get 2.8 gallons of ethanol per bushel, you can kind of figure out where ethanol prices need to be at that kind of forward market on corn. And that's what we're trying to say there.

Steve Denault, Northland Securities.

I know last -- 90 days ago you had kind of referenced being hedged in the first two quarters of '08. About two-thirds of your corn input costs were hedged and I think it was at 370-ish levels. And so, it sounds like you haven't put too much more in the way of hedges on it for the balance of the year.

Like I said, we have kept up to about 75% for the rest of the year. So not a lot in the last 90 days.

Okay. And then in terms of ethanol contracted out, is it still kind of about 25% is entered into and via forward contracts?

The ethanol contracting has really slowed down in the last several months. I mean, you can do contracts going out a lot further at a much discounted price. So, we have tried to stay closer to the spot market price with our ethanol and have done less forward contracting.

Okay. And I thought I remember 90 days ago, you sort of referenced being more hedged on wheat than what you're conveying today. Is that not the case?

I don't think so.

Okay.

Yes, I guess the way to think about that, though, Steve, is we're now into the second week in February. And so -- I mean, and when we're giving you numbers, we're talking about from this day forward. So we're already a month and two weeks into this current quarter and we've ground that wheat. So, I think we're staying pretty consistent.

Okay. In regards to the vital wheat gluten, I know that imports have slowed some. Are you making money on vital wheat gluten at this point?

You have to remember the way that the integrated process works that we have. We bring -- we buy the wheat bushel, we run it through our flour mill. We get a certain amount of pounds of protein and a certain amount of pounds of starch out of every 100 pounds of flour that run through our process, Steve. So, we cannot and do not take profitability down to an SKU or that type of product level.

So we can't really tell you -- and it doesn't really make any sense for us to think about it from that perspective. What we look at is how much are we getting for those pounds of protein and how much are we getting for those pounds of starch that we get out of that 100 pounds of flour. And that's what you're seeing reflected in this Ingredients Solutions segment reporting.

So, gluten prices are up dramatically over a year ago. We're running 2.5 times the rate we were running a year ago, which is generating more starch, which is helping fund the increase in the top line in the specialty starch area that we talked about. So, overall -- and obviously, our losses are significantly less than they were a year ago. So I would have to say we're doing much better than we were a year ago, but in terms of being able to tell you (multiple speakers) --

You can't really answer his question.

Yes. You can't -- yes. Because we just don't think about it like that.

Yes. No, that makes sense. I completely understand that. How about this -- can you tell me what -- maybe what vital wheat gluten pricing is today on a per pound basis versus maybe where it was 180 days ago and 90 days ago?

To be honest with you, I don't really know for sure where I would call the market today. Because when you're looking at -- first of all, most of the contracting in the vital wheat gluten area is done on a calendar year basis, Steve. So we would have finished most of the contracting in that last October/November period.

There is not a good market out there right now for anybody offering gluten at all. Mostly because you're looking at Minneapolis wheat, $15; Kansas City wheat -- when you put the basis and think about it from a cash perspective, somewhere around $12 or $13, you just can't -- the gluten price would have to be -- I don't know, $1.50 or $1.60 for somebody to make any incremental pounds.

So, I would say though that when we were doing the contracting in that October/November period, we were up almost 80% over where we would have been the year before. So, the gluten prices came up. We did a bunch of contracting. We hedged some wheat. And now, if you had to call it today, it would be, I'd say, somewhere in that $1.50 area easy.

(OPERATOR INSTRUCTIONS). Richard Holt, Wealth Monitors.

I just have a quick question on the alcohol production targets. If the goal was 10% to 15%, what was the actual percentage during the quarter?

On an actual realized throughput?

Yes.

We were probably about 85%, 88%.

88% of the 10% to 15%?

No. We would have been -- I mean, if you take our original base that we talked about and then you take that up, what we debottlenecked a year ago, the 10% to 15%, with that number, which is somewhere around that 127 million, 130 million gallon range, and about roughly 85% of that in that second quarter.

Okay. And what do you expect that to be in Q3?

I'd expect somewhere, Brian, maybe mid-'90s any way.

Yes, 90 to 100% of that.

And just a follow-up question on Jonathan's earlier question. With the focus in the increased spending in the Other segment, that would imply that you're expecting significant revenues in the future -- or greater revenue streams in the future. How soon can we expect to see those?

Yes, Richard, those are businesses that are really in their infancy and just really kind of getting going. Again, when you think about the pet side, that business was turned on its ear a couple of years ago when we lost our major customer and to get -- had to change our model from just simply producing an ingredient to making final finished retail-ready products. And so that has been a real long haul and an upward battle.

When you think about the biodegradable plastics business, again, that's one where we've installed the capital, we're beginning to build those markets. We're beginning to get those new formulations out. Like I said, kind of answered Jonathan's question, I'd expect to see some improvements here within six months, but before those can become real positive, consistent, sustainable contributors, you're probably looking 12 to 18 months out, I'd say, to be fair. But those -- because those are brand-new technologies for us.

Those are really developing businesses, so, you really have to almost look at those expenses as investments going forward into these businesses.

Yes. That's how we were thinking about it. And going back to the food grade beverage, you had mentioned that the pricing was higher but the demand was lower. Was the demand lower on the food grade beverage or the industrial?

The demand was minimal lower, but that was just more affection of a little bit of seasonality. But we still feel going forward that demand remains very strong in that area.

In both segments? Or on both sides, the industrial and the food grade beverage?

Yes, that's correct.

And the pricing is holding steady or increasing?

Yes.

Okay. Thank you very much, gentlemen.

Thank you. There are no further questions at this time. I'd like to turn the floor over to Ladd Seaberg for closing remarks.

Okay, well, thank you for joining us this morning. And we look forward to talking with you again when we report our third quarter earnings. This concludes our call at this time.

Thank you. This concludes today's conference call. You may now disconnect.