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MGP Ingredients, Inc. (NASDAQ:MGPI)

F1Q09 (Qtr End 09/30/08) Earnings Call Transcript

November 11, 2008, 11:00 am ET

Executives

Steve Pickman – VP, Corporate Relations

Tim Newkirk – President & CEO

Robert Zonneveld – VP, Finance and Administration & CFO

Analysts

Steve Denault – Northland Securities

Operator

Good day, everyone, and welcome to today’s MGP Ingredients Fiscal 2009 First Quarter Conference Call. Today’s call is being recorded. At this time, I would like to turn the call over to Mr. Steve Pickman, Vice President of Corporate Relations. Please go ahead, sir.

Steve Pickman

Thank you. Good morning and welcome to this morning’s conference call. Very shortly, Tim Newkirk, our President and CEO, will provide comments related to our first quarter earnings announcement as well as the news regarding our recent restructuring plans. Also joining us this morning are Robert Zonneveld, Vice President of Finance and CFO, and Don Coffey, Executive Vice President of our Ingredient Solutions business segment.

Before Tim begins and prior to taking questions this morning, we need to note the following. Any forward-looking statements that we might make today are qualified in the following respect

There are a number of factors that could cause our actual results and any guidance to vary materially from expectations. Additional information about these factors may be found in the reports that we filed with the Securities and Exchange Commission. These include our Annual Report in Form 10-K and quarterly reports and 10-Q.

I would also like to mention that this conference call is being webcast and is open to analysts.

Now I would like to turn the call over to Tim.

Tim Newkirk

Thank you, Steve. Good morning, everyone, and thank you for joining us on this conference call. As you know, we have been running at full tilt to transform this Company. I want to start with a brief overview of the quarter we reported yesterday. Then I will give you more context around our recent restructuring actions. Robert will then cover the financial highlights of the quarter, including the subsequent actions we have taken. At the end of our remarks we will be glad to open up the call to your questions.

Our first quarter looked very similar to our recent fourth quarter, the main culprit again was higher pricing for our key inputs. The per-bushel cost of wheat for the first quarter increased by 41% over the same period a year ago. The per-bushel cost of corn before adjustments related to hedging practice averaged 49% higher than one year ago. Finally, the average cost for natural gas increased 42%. So, in total, while our sales of $99 m represented a 13% increase above last year’s first quarter, our profitability was eroded by a significant increase in our cost of goods sold related to raw material and energy expenses.

Since you have our quarterly earnings release, I am not going to spend time reciting all the numbers. We reported a net loss of $17.2 million in the fourth quarter equating to a loss of $1.04 per diluted share. Robert will talk more about our quarterly financial results in a few minutes.

Let me now move on to explain our recent actions in the context of our overall strategy. We are implementing a business transformation program that is expected to bring measurable rewards over the long term as we continue to exit underperforming businesses and refocus on our core strengths and growth strategies. We are working to improve the value of what we do by retaining those parts of our business in which we are competitively advantaged. For example, we are among the best at applying grain science to create complex formulations for specialty ingredients, specifically wheat proteins and starches, while also strengthening or role as a leading provider of high-quality, world-class alcohol products.

On the other hand, there are areas in which vertical integration no longer make economic sense. We took a big step recently by announcing an agreement with ConAgra Mills to supply our wheat flour requirements going forward. Along with the cost of producing our own flour in the past we had to carry excess stockpiles of material before it can be processed into proteins and starches and not always at a profit. Now, we will be able to move forward with more stable, lower cost (inaudible) on a just-in-time basis and a more productive use of our working capital. This is just one more part of MGPI’s plan to improve profits, generate cash and reduce risk. It doesn’t get anymore basic than that.

So, let’s move on to the news we recently announced, the decision to consolidate the production of our proteins and starches at our facility in Atchison, Kansas, effective November 12. This means the discontinuation of protein and starch operations at our Pekin, Illinois facility and a resulting decrease in the manufacturing of commodity and other lower-valued ingredients in these two specific product areas. We will now concentrate our efforts on the production of value-added Ingredient Solutions in Atchison.

The discontinuation of protein and starch operations in Pekin will unfortunately result in a combination of layoffs and early retirement offers, affecting from 70 to 80 union and non-union employees across the organization. These actions are part of efforts to help realign MGPI’s organizational structure with the Company’s long-term strategic focus. These are all very painful decisions, but unavoidable from a perspective of actions we must take to make MGP Ingredients a stronger, more competitive organization.

With the reconfiguration of our operations, we will be removing a layer of revenues that have contributed very low profits or even losses as well as negative returns on investment. To put some size around this, our fiscal 2008 revenues from accounted for about 9% or $35 million of our total revenues. As you may know, the Company operates a larger distillery operation at the Pekin facility, which has undergone major upgrades since MGPI’s acquisition of that plant in 1980. The decision to halt protein and starch production in Pekin will have no impact on the facility’s distillery operation. However, fuel-grade alcohol production, which this past fiscal year accounted for approximately 76% of the Pekin distillery’s total alcohol capacity will be curtailed until pricing and cost factors turn more favorable.

Meanwhile, we are pursuing ways to optimize production volumes of our high-quality, high-purity, food-grade alcohol in both Pekin and Atchison. I said earlier that we were anticipating measurable benefits from these latest actions, but please be aware that this is not just about quick-fixes. Quite some time ago we began the ambitious work to drive excellence deep into specialty ingredients and high-quality, food-grade alcohol products, our two core segments.

All of our efforts have been directed in improving the value of what we provide the customer. In this process, we asked ourselves the hard questions such as which business areas and projects we are not creating value. Could some of our raw materials be provided more effectively by a third party? Can we consolidate the number of product SKUs? What additional services do customers want and deserve? How could management be strengthened? What investments and business improvements could reap long-term value-creating benefits?

Considerations given to all of these questions factored into the tough decisions we have made to support the continuing transformation of our Company into a truly value-added and more focused business.

Now, I would like to turn this discussion over to our CFO, Robert Zonneveld, to provide more background to our quarterly results as well the financial aspects of our recent decisions. Robert?

Robert Zonneveld

Thank you, Tim. As with Tim’s remarks I will confine my discussions to a few highlights since everybody has the earnings release with the financial tables.

As noted in the release, we have completed a second amendment to the credit agreement. The highlights include the following. The standstill agreement has been extended to February 27th or earlier if we have a forbearance to follow. Interest rate will be plan plus 3%, but the agreement has a interest rate forward of 7%. The financial covenants are monthly year-to-date EBITDA targets and other non-financial requirements exist.

We also expect to receive approximately $9.2 million in tax refunds during our second quarter. The tax refunds will be used to pay down the credit line. While our credit lines (inaudible) at $55 million the uses of the cash received from the tax refunds will be restricted to be used only for our grain hedging activities, including margin cost.

A more detailed amounts of our liquidity and capital resources and the amendment to the credit facility are included in the 10-Q we filed yesterday.

Just as we move into becoming a more customer-centric Company, we are also becoming a Company whose decision-making is data and information-driven. The investment the Company has made in both operational and financial reporting has given MGP the transparency to understand the key drivers and has enabled us to make the difficult but (inaudible) decisions to change how we operate the Company.

I will right now like to discuss details on our restructuring plans. As we had previously announced, as a result of the shutdown of the protein and starch operation in Pekin and the flour mill operation in Atchison, we will now non-cash charge writedown estimated at $6.9 million during our second quarter.

The flour mill writedown does not include cost related to leased rail cars associated with flour shipments to the Pekin facility, the effect of which is still being evaluated by the Company currently. The Company now expects to incur an estimated $3 million loss resulting from sales of wheat no longer needed for milling operation.

Related to these wheat sales, the Company had approximately $1.2 million in deferred hedging gains, which is expected to be recognized in the second quarter. The Company additionally expects to incur approximately $2.5 million in severance charges related to early retirements and job eliminations during the second quarter.

The new flour supply agreement allow us to get just-in-time delivery of flour and eliminates the need for us to invest in wheat. This along with consolidation of the production of value-added grains in Atchison greatly shortens the amount of working capital tied up in our supply chain.

We also continue our efforts to deleverage our balance sheet by reducing the amount of finished goods we maintain in inventory. We continue to drive the organization to be more customer-centric by only producing what we sell, not selling what we produce. This along with our efforts to streamline our distribution of finished goods and the procurement of raw materials will greatly reduce the time it will take from the day we invest a dollar in raw materials to the day we collect our receivables from our customers.

Finally, we are changing the way we are defining success and risk management. No longer is buying grain at lower cost than our competitors the measure of success. We measure success by focusing on margin – on managing our margins. (Inaudible) we will match our sales program with grain cost procurement to lock in margins.

Total margin management will be key to our success in managing how we buy our raw materials, manage our production cost, and control our SG&A operating cost as well as finally how we manage the sales process with our customers.

Before I close, let me say a few words about the broad based performance improvement program. Many of the initiatives that are underway should yield results, as Tim alluded to earlier. We will now be more capable on concentrating on our higher margin ingredients and alcohol products while strengthening our operational efficiencies. Additionally, we will see a reduction in our SG&A expenses to the tune of $2.1 million on annualized basis.

Although we anticipate operating loss for the year, our aim is to return to Company profitability by next fiscal year.

To summarize the bottom line impact we hope to achieve from our recent actions. Actions are intended to create greater value for our customers and our shareholders.

Now, I will like to turn the call back over to Tim.

Tim Newkirk

Thank you, Robert. Adding to what Robert said, another key element for the success of our performance improvement program is human performance leadership. Over the past year, in particular, we have attracted many high performers with deep experience in the critical areas of sales development, commercialization, plant management, and finance. Given the volatility in the commodity markets we also elevated risk management to a new level by creating a shorter supply chain and adopting more effective margin management programs.

MGPI has a long legacy of successful manufacturing. Much of that footprint will continue to serve us well. However, our future will be determined by our ability to transform from a manufacturing mindset to one that is truly customer-driven. For instance, in specialty ingredients, instead of measuring pounds produced, we will be keeping a close eye on the number of problems solved.

While I am on the topic of ingredients, let me say just a few words about our strategy. In the past we were able to score a number of home runs with the latest resulting from the low-carb fad. This is not typically how the industry works. In fact, just like the leading hitters, who also tend to lead in strike-outs, we need to generate a lot more new ideas for our food customers in hopes of scoring a sizable new product order.

Don Coffey, who is principally responsible for our Ingredients segment, is charged with getting our people deeper into our customer base to the point where we become part of the fabric of any one company. It’s all about numbers. The more new products we have in our pipeline, the greater our chances of success. Don tells me that we have over 50 customer projects in the works, and he thinks we can eventually double that number over time.

We want MGPI to be the first call when a customer has a challenge. Even though we are still early in building our new applications and service network the initial results are encouraging as measured by the value-added products we create and get paid for.

That concludes my prepared remarks. Now we are ready to open the line for questions.

Question-and-Answer Session

Operator

(Operator instructions) We will take our first question from Steve Denault with Northland Securities.

Steve Denault – Northland Securities

Good morning, everyone.

Tim Newkirk

Good morning.

Steve Denault – Northland Securities

You made some reference to intending to return of profitability, I didn’t catch the timing or timeframe.

Tim Newkirk

See – this is Tim – we are expecting to be – to return to profitability by the next fiscal year.

Steve Denault – Northland Securities

Okay. How unprofitable in the most recent quarter would you say the wheat gluten and commodity starches were?

Tim Newkirk

In the – in that Ingredients segment, the majority of those losses were driven by those commodity ingredients.

Steve Denault – Northland Securities

Okay. And most of which aren’t sold on contract, I would imagine, right? I mean if they are commodity (inaudible) it’s easy to walk away from it.

Tim Newkirk

That’s yes – that’s generally true, see that ourselves, there will be some contracts, but most of those because of the time of the year that we are in most of those are calendar year contracts and are basically winding down here in the second quarter.

Steve Denault – Northland Securities

Okay. If I look at the Distillery Products segment, the $12.9 million operating loss, anything abnormal in that number?

Tim Newkirk

No, that’s really a function , Steve, I think of what we’ve seen in the overall industry with the – we basically came through the highest prices corn in that quarter. We had very high natural gas prices peaking (inaudible) we had $140 oil in that quarter and obviously the rapid erosion of margins in the fuel ethanol market, all of which really affected that fourth quarter, but nothing unusual – I mean those are – fortunately those are unusual events in and of themselves, but there was nothing within the operations that was unusual.

Steve Denault – Northland Securities

Nothing. And in terms of hedging at high levels on corn or anything like that?

Tim Newkirk

Not relative to the price of corn at the time.

Steve Denault – Northland Securities

Okay. What are your hedges look like heading into the December quarter?

Tim Newkirk

We are running out of all of our hedged position within this current quarter on the corn side and are open after the end of this quarter. Sometime during this quarter we should use up all of the hedged grain that we have. Natural gas, as we talked about, in our fourth quarter earnings call is hedged for the remainder of this fiscal year.

Steve Denault – Northland Securities

Okay. And I missed the comment on SG&A expense reduction. There was something about $2.1 million?

Robert Zonneveld

Yes, we expect SG&A to be about $2.1 million than we originally planned for this year, lower.

Steve Denault – Northland Securities

Okay. $2.1 million lower on an absolute basis?

Robert Zonneveld

Right.

Steve Denault – Northland Securities

Okay. Perfect. Thank you.

Robert Zonneveld

Thanks, Steve.

Operator

(Operator instructions) And there are no more questions at this time. I would like to turn the conference back over to Mr. Tim Newkirk for any additional or closing comments.

Tim Newkirk

Thank you. This is Tim Newkirk again. Let me conclude my remarks by saying that these difficult decisions regarding changes in the Company’s operations have been driven by our need to focus on those areas where we can sustain a competitive advantage while reducing our earnings volatility caused by uncontrollable external factors such as we have witnessed in the commodity markets. Although recent economic conditions have caused us to accelerate some of these decisions, they all stem from an exhaustive business analysis spanning our entire enterprise. Additionally, every facet of our organization will aim to improve profitability while ensuring proper alignment with our strategic focus going forward.

We thank you for joining us this morning. We look forward to talking with you again when we report our second quarter earnings. This concludes our call.

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