Penford Management Discusses Q2 2013 Results - Earnings Call Transcript

Apr. 5.13 | About: Penford Corporation (PENX)

Penford (NASDAQ:PENX)

Q2 2013 Earnings Call

April 05, 2013 10:00 am ET

Executives

Steven O. Cordier - Chief Financial Officer, Principal Accounting Officer, Senior Vice President and Assistant Secretary

Thomas D. Malkoski - Chief Executive Officer, President and Director

Analysts

Jeffrey Schnell - Jefferies & Company, Inc., Research Division

Gunnar Hansen - Sidoti & Company, LLC

Frank F. Rango - BKF Asset Management, Inc.

Tom Spiro

Operator

Greetings, and welcome to the Penford Corporation's Fiscal Year 2013 Second Quarter Results Conference Call. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Steven Cordier, Chief Financial Officer for Penford Corporation. Thank you, Mr. Cordier, you may begin.

Steven O. Cordier

Thank you, Kevin. Good morning, everyone. Thank you for joining our conference call to discuss Penford's second quarter fiscal 2013 financial results. Before we get started, let me caution you about any forward-looking comments we might make today. Any forward-looking statements regarding future events or the financial performance of the company are just predictions, and actual events or results may differ materially. Any forward-looking statements are subject to numerous risks and uncertainties. These include the performance of the economy as a whole and its impact on Penford's customers, increased competition and raw material, chemical and energy costs. Please refer to the documents that we file from time-to-time with the Securities and Exchange Commission for a discussion of these and other risks and uncertainties. And finally, we do not undertake to update publicly any forward-looking statements to reflect new information, events or circumstances after the date of this call or to reflect the occurrence of unanticipated events.

Today, we reported financial results for our fiscal 2013 second quarter, showing year-over-year improvements in revenue, net income and earnings per share. Consolidated sales for the second quarter of fiscal 2013 rose 3.3% over the previous year to $89 million. Both our Food Ingredients and Industrial business segments posted higher quarterly revenue, driven by improved pricing and sales from acquired operations of Carolina Starches.

Net income was $1.2 million for the quarter compared to a loss of $300,000 a year ago. Diluted earnings per share improved $0.10 from a loss per share of $0.03 in last year's second quarter. Gross margin expanded 17% from a year ago to $11 million, and gross margin as a percent of sales expanded 150 basis points to 12.4%. Improvements in pricing and product mix contributed to higher margins.

Operating expenses increased $700,000 to $7.2 million in the second quarter primarily due to 3 factors: the inclusion of expenses from Carolina Starches operations acquired in January 2012, higher pension expenses and additional employee costs to support new business initiatives.

Consolidated operating income for the second quarter increased 53% to $2.5 million as revenue and margin expansion outpaced operating cost. Second quarter interest expense is $1 million, less than half of last year's expense of $2.4 million. The decline in interest expense was due to the redemption of the company's preferred stock in the latter half of fiscal 2012. The interest rate on the company's bank debt at February 28, 2013, was 3.7%. We expect that interest expense in fiscal 2013 will be variable based on LIBOR.

The company's effective income tax rate was 34% in the first half of fiscal 2013 versus 82% a year ago. Last year's tax reflect -- tax rate reflected the preferred stock dividends, discount accretion and the amortization of preferred stock issuant costs, which were recorded as interest expense but were not deductible for tax return purposes. We expect the effective tax rate in fiscal 2013 will be in the 34% to 36% range.

$3.8 million was used in cash by operations during the second quarter, similar to last year. The primary use was to fund higher value raw material and finished goods inventories. Capital spending for fiscal 2013 is projected in the range of $14 million to $15 million as we complete projects carried into this year and undertake initial stages of several projects scheduled for completion during fiscal 2014. The company's balance sheet remains strong with total debt outstanding at $85.6 million. Leverage has increased by $5.6 million from a year ago as the company has funded higher raw material costs, numerous capital projects, as well as the redemption costs of the preferred stock. This underscores the strong cash-generating capabilities of the businesses.

At this time, I would like to introduce Tom Malkoski.

Thomas D. Malkoski

Thank you, Steve. Sales of our Food Ingredients division grew by 7% over last year to $26.6 million. The improvement in revenue was driven largely by growth at existing customers and new business gains in several segments, including dairy, gluten-free, protein and sauces.

Results in our food business reflect the balance of new product introductions, customer reformulations and cost reduction applications. Gross margin grew in line with sales and rose 7% to $8.1 million. Operating income for the second quarter rose over 5% to $5.5 million.

The Industrial Ingredients division reported second quarter revenue increased 2% to $62.4 million. Gross margin improved by 62% to $2.9 million. The operating loss in the Industrial business narrowed by $0.5 million to a loss of $500,000.

Revenue and margin gains reflected several factors, including higher paper starch and ethanol pricing than a year ago, additional modified starch volumes and contributions from the Carolina Starches business. These improvements were partially offset by significantly lower ethanol production and sales.

Penford's second quarter ethanol sales of $18.2 million decreased $6 million or 25% from last year. During the second quarter, Cedar Rapids-based production was shifted towards industrial and food starches, reflecting stronger demand from our customers for these products and margin opportunities.

Choices and finished product priorities led to a decline in ethanol volume of 28% from last year. As a result, ethanol revenue represented 33% of the Industrial division sales in the quarter compared to 42% in the second quarter of 2012.

Looking ahead to the second half of our fiscal year, the Industrial business has secured improvements in pricing and product mix in paper starches that should positively impact performance. Ethanol market dynamics and margins have begun to show improvement in our third quarter compared to the recently completed second quarter, and we expect revenue in our food business to continue to improve for modest growth in our core food segments and from new products just mentioned.

Improvements to our capital structure implemented late in fiscal 2012 have resulted in lower interest expense and taxes contributing to earnings growth, and we expect these lower costs to continue to show in our financials. The news is constantly reminding us of the challenging economic and business conditions. This is the reality that Penford, our customers and consumers face. Recognizing these conditions, we will continue to invest in technologies in application areas that can lead evolving customer needs for enhanced functionality and cost advantage.

Efforts to develop new products are encouraging, and customer trial activity remains strong in our focused areas of food and bioproducts. During the first half of fiscal 2013, the food division introduced several new products and applications, including a highly soluble enzyme-treated starch for enhanced crispness in coated products like french fries, chicken and fish. Our starch portfolio are targeting clean label markets, our cost-effective nonallergenic egg replacer for bakery products and a proprietary resistant starch that provides fiber enrichment and caloric reduction. We expect that these new products should generate commercial orders in the second half of our fiscal year. And I would note, these offerings are aligned with strong trends, specifically health and wellness, consumer interest for clean label products and demand for functional performance.

We're also making progress in our industrial bioproducts. In the second quarter, we added 6 new commercial accounts that should contribute to results in the second half year. At the beginning of our third quarter, we began trials with several customers on a proprietary new bioproducts line called PenStrength, which is positioned to replace synthetic dry strength additives used in recycled boxboard. The product allows packaging customers to significantly reduce fiber costs or create packaging grades. We have filed for patent protection to this novel development.

This week, a customer of ours, Elmer's Products, announced a breakthrough consumer product that they're launching into the marketplace this spring. The product is called Elmer's School Glue Naturals and, according to Elmer's, is the first and only school glue made almost entirely with naturally occurring ingredients. We manufacture this product for Elmer's using our proprietary Penflex technology. Our collaboration with Elmer's exemplifies our approach to partnering with customers to deliver product innovations that are aligned with growing consumer interest in natural and renewable products, which also support our customer sustainability initiatives.

Thank you. And would you please open the call for questions?

Question-and-Answer Session

Operator

[Operator Instructions] Our first question today is coming from Laurence Alexander from Jefferies.

Jeffrey Schnell - Jefferies & Company, Inc., Research Division

This is Jeff Schnell, in for Laurence. A couple quick questions for you. In food and bioproducts, how many products would you say are in trial at any given time? And what's the typical length of a trial before a customer will broadly adopt or put in large orders?

Thomas D. Malkoski

Well, let me address the time line. If it's a new technology that is disruptive either in cost or performance, generally in the Industrial business, that could be anywhere from 12 to 18 months on a cycle. On the food side, it would be that or slightly less depending on the nature of the product, if it's replacing a product that our customers or if it is a new product entirely. What we find at any given time is we would have several dozen trials going on at the same time. And some of these trials would be lab-based trials at the early stage all the way through extended run trials, which are literally the product is running on a machine for 3 or 4 weeks, and at least in the Industrial side of the business, that's the way it would work. On the food side, once the customer is satisfied with the product and they decide they want to convert to the product, it is a pretty quick switch over once they've made that commitment. But as I said, we measure not just the level of trial activity, but we measure the stage and the probability of success at each of the different stages with our -- each of our products.

Jeffrey Schnell - Jefferies & Company, Inc., Research Division

Great. And then in Food Ingredients, are your customers pushing back on pricing to protect their margins or are you seeing they're adopting it?

Thomas D. Malkoski

We're actually seeing both now that -- on the encouraging side, we're seeing a pretty healthy mix of interest in new products and in formulations that reduce cost. And remember, when we talk about many of our products, a lot of our food products offer a cost reduction opportunity for our customers. It's not based on lower pricing. It's simply that our ingredients work better than more expensive ingredients that they may be using or, and in many cases too, let's say, it's a french fry coatings customer, we'll have formulations that could improve product integrity, but we also have cost reduction formulas, it depends on what they are most interested in. We do recognize that the food industry is very competitive right now, and we're seeing a little bit slower growth than what we had seen, say, a couple of years ago. But we are seeing growth in the food industry, both in the quick service side and, in particular, in the casual dining. They're called the fast casual dining that are really picking up steam. And we're seeing some modest improvements in the branded or the retail side of it.

Jeffrey Schnell - Jefferies & Company, Inc., Research Division

And then one last question, if I may. On R&D, the sequential drop in R&D, do you expect this to be a new run rate? Or will you expect it to pick up in the back half of the year?

Thomas D. Malkoski

Well, I think it'll pick up slightly back to sort of the guidance I gave on the last call. I articulated that I figure that our R&D spending will be 9% or 10% above the previous year. Some of it though depends on when either certain studies or key trials actually fall. And so it can be lumpy quarter-to-quarter, but I think the trend line is going to be high single digits, maybe up as much as 10%.

Operator

[Operator Instructions] Our next question is coming from Gunnar Hansen from Sidoti.

Gunnar Hansen - Sidoti & Company, LLC

With the -- you guys mentioned the sequential improvement, I guess, for this quarter in terms of ethanol pricing. How do you guys kind of see volumes kind of working out going forward?

Thomas D. Malkoski

Well, right now, the market is acting as if it's short ethanol. The stocks of ethanol have dropped from 24, 25 days just 3 months ago to somewhere around 17 or 18. And we do see dislocations in some markets. I think the market will be working hard to get ethanol for supply, and so we see that as an opportunity both in terms of the volume of ethanol but also in terms of the margin structure for ethanol. And at this moment we're running our ethanol pretty hard, and that's quite a change from where it was just a couple months ago.

Gunnar Hansen - Sidoti & Company, LLC

Okay, great. And I think you also mentioned you guys had 6 new commercial accounts in terms of the bioproducts, is that right?

Thomas D. Malkoski

Yes.

Gunnar Hansen - Sidoti & Company, LLC

And I guess what existing account base do you guys have? And I guess where does that kind of bring you to?

Thomas D. Malkoski

Well, we've got more than 30 companies that we serve with our bioproducts and more than 50 accounts. And I'd rather not be more specific, but it easily compares those 2 numbers.

Gunnar Hansen - Sidoti & Company, LLC

And in terms of segment breakdown, how much does bioproducts account for now?

Thomas D. Malkoski

It's still relatively small when we look at the size of our starch and ethanol businesses, but it is approaching the 10% mark.

Gunnar Hansen - Sidoti & Company, LLC

Great. And just in terms of the food product introductions and kind of the expectations for the second half year, how do you guys kind of see that shaking out?

Thomas D. Malkoski

Well, we see -- we showed some pretty good growth at 7% in the second quarter. My expectation is that we'll see a little bit of a pickup there just based on what's in the pipeline and where we are in converting on some of these new products.

Operator

Our next question is coming from Frank Rango from Purchase Capital Management.

Frank F. Rango - BKF Asset Management, Inc.

A couple of questions. Tom, I think you said at the beginning of the call that you kind of expected that food products' top line growth would a same single-digit type of growth that you've exhibited this quarter over previous year, is that correct?

Thomas D. Malkoski

Well, I didn't say specifically. But yes, we -- the indication is that it will be somewhere in that range, maybe a little better.

Frank F. Rango - BKF Asset Management, Inc.

Okay. If you could help me here a little bit, because it sounds like you're saying there's a better product introduction cycle coming up, or at least it sounds like that in terms of the number of products. You're talking about this Elmer's glue product and a couple of other products on the food side. So if that's only adding up to single-digit improvement, that means that probably your -- some other products are falling by the wayside or maybe losing some traction in the market.

Thomas D. Malkoski

No, not really so much, Frank. The pacing that we talked about in terms of commercial introductions still takes time. And so when I talked about gaining new accounts in bioproducts in our Q2, the timing of when the real commercial volume growth will show up in the P&L will be paced out over the next few quarters. And the same thing with the introductions of food, where in our food group and in some of these products, we announce an introduction of a new technology or a new family of products, and then we go forward and sell in. And my indication is that we're in trials with some of our customers on those new products, but I don't expect that there'll be a heavy amount of that new, but I do expect some. I was indicating we'll start to see some of that showing up. But I do think that it'll take us a few quarters to get the full value of some of the new products.

Frank F. Rango - BKF Asset Management, Inc.

Okay. And you highlighted a new product that's for french fries, a coating for french fries?

Thomas D. Malkoski

Yes.

Frank F. Rango - BKF Asset Management, Inc.

Is that in replacement for the product you sold to Burger King?

Thomas D. Malkoski

It already has done that, yes, but we also have it rolling out to some other types of products, so it goes beyond french fry coating.

Frank F. Rango - BKF Asset Management, Inc.

Okay, got it. And in terms of the industrial side, with ethanol ticking up, and you seem to be more optimistic on make some more money in ethanol in the near-term here, should we look for sharp improvements for the rest of the year for Industrial?

Thomas D. Malkoski

Well, we're not -- we don't normally give any indication of expectation around the P&L, but we do expect that Industrial will perform better certainly in the near term. And ethanol is part of it, but we think the other legs of the business are going to perform as well or better than they have.

Steven O. Cordier

And this is Steve Cordier. One other point to make in the ethanol market itself is that while the current conditions have improved, the ability to hedge forward at favorable margins still remains difficult, even more difficult than before because the corn element has been moving around so much. So we're not -- while we're seeing the supply-demand situation improve and the margins in the near term had improved, we can't lock that in so we're kind of, if you will, trading on a spot basis. We were looking for the supply-demand situation to stay strong, but we are not in charge of or have the ability to lock that in.

Frank F. Rango - BKF Asset Management, Inc.

Right, right, and that's clear. But lower corn prices, if they stay down should be helpful there, right?

Steven O. Cordier

Yes.

Operator

[Operator Instructions] Our next question is coming from Tom Spiro from Spiro Capital.

Tom Spiro

Tom Spiro, Spiro Capital. Tom, I know we've been working hard to develop some strategic partnerships. And I wondered, could you update us, please?

Thomas D. Malkoski

Well, we continue to work on the bioproducts side and we also have some others that are being worked on the food side. And when they are -- when it is appropriate, we would announce them. But I would say that negotiating partnerships does take a fair amount of time.

Tom Spiro

How do you know, Tom, whether you're actually making progress or you're just sort of cold-calling a lot of folks and really not making a great deal of progress?

Thomas D. Malkoski

Well, that's a fair question. Part of it is the nature of understanding both parties' interests, and so aligning the interest is usually the biggest challenge, and once you've done that, then it's -- then we've seen some progress in some and in others, we see that we both have to walk away for at least some period of time.

Steven O. Cordier

Tom, there are a number of benchmarks and milestones that we know that are obviously not going to be discussed publicly, but you have introductory meetings. You might move to senior management, face-to-face meetings, and you exchange confidentiality documents. You might move to a nonbinding expression of interest and on and on and on. There are typical milestones in the process that you can benchmark, and we pay very close attention. And so we are able to say whether or not we're getting somewhere on these. It's not just an amorphous process.

Tom Spiro

Well, that's helpful. Tom, I think you mentioned earlier in the call that at least the near term we'll be ramping ethanol volumes up, and I'm guessing that we're probably -- we've been running pretty close to capacity for some time. If I'm right, what are we ramping down to -- so that we can ramp the ethanol up?

Thomas D. Malkoski

We have the ability to ramp the ethanol up a bit more and without sacrificing any of the starch volume. And as you know, we've already stated the priorities of the business are to support the bioproducts and the food in whatever growth needs it has out of the Cedar Rapids facility. And of course, food plants do support everything related to our food growth, but we do have the ability to flex ethanol up and down depending on market conditions.

Steven O. Cordier

During the first half of the year, particularly the second quarter, the throughput in the Cedar Rapids plant was below full capacity, so we can bring that back up. We weren't sacrificing higher-margin starch or bioproducts sales for that. We ended up just not running the plant as hard.

Tom Spiro

Are we at full capacity now?

Steven O. Cordier

We are pretty close now with the margins we're seeing in ethanol and the appeal of that market.

Tom Spiro

Tom, Carolina Starches, we've owned it now for time. And apart from whatever money we make from it, are there kind of strategic sorts of things that we're now capable of doing, that we weren't capable of doing before the acquisition?

Thomas D. Malkoski

Well, yes. And I indicated that some of the reasons that we chose to move forward with the acquisition related to strengthening our advantages in supply chain and in operations. And we see those advantages, and we see even more coming. We have -- in the acquisition, we acquired some pretty good talent, both on the commercial side and on the operations side, and so we're very pleased with that. It's always a tough one to gauge during an acquisition, is to whether you're actually getting incremental value out of talent, and we did. And we also see some commercial opportunities that we were not aware of, that are being brought forward through the context of the Carolina Starches people, and so we're very pleased with that as well.

Tom Spiro

Are those industrial or food opportunities?

Thomas D. Malkoski

Both.

Tom Spiro

I see, I see. And last question, Steve, do you expect the company to pay down any debt this year? Or do you think our debt will grow by year end?

Steven O. Cordier

I think the goal is probably to hold the debt levels near where they are. We have some additional spending on capital projects and other initiatives, so I would not expect to have a significant reduction in the leverage, but we are watching that so that we can manage that debt level through the additional expenditures.

Operator

Thank you. There are no further questions at this time. I'll turn the floor back over to management for any further or closing comments.

Thomas D. Malkoski

Thank you very much for participating. If there are any follow-up calls, you can reach me at the number at the top of the press release.

Operator

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

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