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Penford (NASDAQ:PENX)

Q4 2013 Earnings Call

November 14, 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

George D'Angelo - Jefferies LLC, Research Division

Conner McMahon - Sidoti & Company, LLC

Frank F. Rango - BKF Asset Management, Inc.

Tom Spiro

Operator

Greetings, and welcome to Penford Corporation Fiscal Year 2013 Fourth Quarter and Year-End Results Conference Call. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Steven Cordier, CFO. Thank you, sir, please go ahead.

Steven O. Cordier

Thank you, Brenda. Good morning, everyone. Thank you for joining our conference call to discuss Penford's fourth quarter and fiscal year-end 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 to 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 fourth quarter and year-end. Both of our business segments posted higher revenues for the fourth quarter and the year, and net income for the company was -- rose $13.6 million from last year.

Consolidated sales for the full year rose 8% over the previous year to $467.3 million on higher prices and improved product mix. Net income was $4 million, up from a loss of $9.6 million in fiscal 2012. Diluted earnings per share improved to $0.32 from a loss per share of $0.78 last year. Gross margin expanded to $45 million from $43.9 million a year ago. For the fourth quarter, consolidated revenue rose 6.5% to $117.4 million from $110.2 million a year ago, on higher average selling prices and volume gains across specialty categories in both food and industrial. Gross margin deteriorated in the fourth quarter, primarily due to much higher corn costs in the Industrial Ingredients division.

Fourth quarter net loss of $900,000 is still a substantial improvement over last year's fourth quarter loss of $4.4 million. Improvements to our capital structure in the second half of fiscal 2012 have resulted in much lower interest expense, with full year interest expense of $4 million, less than 1/2 of last year's expense of $8.6 million.

The company's effective income tax rate was 27% for fiscal 2013, primarily due to R&D credits applied through a relatively low base of taxable income. Cash of $10.1 million was generated by operations during the fourth quarter, compared to a use of cash of $4.1 million in the same period last year, mainly due to much lower levels of expensive raw material inventory. Capital spending for fiscal 2013 was $12.1 million, including $2.1 million credited from the receipt of a litigation settlement with a vendor.

Approximately 40% of the spending was for growth and productivity projects, with the remainder allocated to maintenance and safety projects, including 2 large installations to improve plant reliability and throughput in Cedar Rapids.

Planned expenditures of about $20 million in fiscal 2014 are allocated about 2/3 for growth and productivity return projects. We anticipate approximately 60% of the projected funding will be within the industrial segment, with the remaining 40% within the food business.

The company's balance sheet remains strong, with long-term bank debt at $71.5 million in August 31, 2013, down $11.1 million from the last fiscal year. The debt to investment capital ratio was 47% at August 31, down 8 percentage points from last year.

At this point, I would like to introduce our CEO, Tom Malkoski.

Thomas D. Malkoski

Thank you, Steve. The Food Ingredients business continued to perform well throughout the fiscal year. Sales rose 8.5% to a record $111.2 million. The increase was driven by broad-based growth in several application segments including protein, soups and sauces, dairy, gluten-free and pet categories.

Fourth quarter revenue grew by 11.3% to $28.4 million, primarily on new business gains across the several application segments just noted, and stronger coatings business, which was up over 10% in the quarter.

Operating income improved 7.7% for the full year and by 22.7% in the quarter. Revenue in the Industrial Ingredients segment reached record highs, but higher costs impacted quarterly and annual results. Full year revenue increased 8% to a record $356 million, while fourth quarter revenue improved 5% to $89 million from year-ago levels.

Annual revenue of our industrial specialty products, which includes certain high-value modified starches and bio-products, improved by more than 25% through growth at certain customers and new business gains.

Full year core industrial starch for paper customers grew revenue by 5% on slightly lower volume, while ethanol revenue declined by 5% on 7% lower volume.

Fourth quarter revenue from industrial specialty products grew by over 10%. Corn industrial starch revenue fell 7% from demand softness, and this led to shift towards higher ethanol production and resulted in ethanol revenue extending by over 20%, with volume of gallons sold up 15% in the quarter.

Fiscal 2013 fourth quarter operating results were especially disappointing, as this segment reported a loss of $4.7 million compared to a year-earlier loss of $800,000. Unprecedented corn market dynamics had a significant impact on the cost and availability of corn, leading to volatility in cost of physical raw material and in pricing of bio-products. Corn volatility also translated into weakness in ethanol margins during the quarter.

These corn market dynamics added over $3 million of cost of sales in the fourth quarter. Higher manufacturing costs including chemicals, energy and unplanned downtime caused by equipment outages also increased cost of sales by about $1.5 million during the quarter.

Improvements in our businesses during fiscal 2013 across several performance measures were partially overshadowed by disappointing fourth quarter results, stemming from difficult market conditions just described. As we would expect, a strong new crop corn harvest is settling corn market dynamics closer to historical patterns. This is having a positive effect on our industrial starch-based products and on ethanol margins into our new fiscal year.

Chemical and energy costs have stabilized, or are moving lower, and we have implemented initiatives to increase plant reliability and reduce production costs that should help contain costs in fiscal 2014.

We also expect to see continued contributions to our food and industrial businesses from our sustained investments in R&D, business development and the depth and capacity of commercial resources.

Company resources are focused on: delivering on the needs of customers through exceptional service and value-enhancing products; shifting our business mix to more specialized higher-value products that address relevant market trends and offer performance in value to customers; managing costs and operating performance sufficiently to support investments to transform the business; and improving cash flow and returns for investors.

This concludes our prepared remarks and please open the call for questions.

Question-and-Answer Session

Operator

[Operator Instructions] And our first question comes from the line of Laurence Alexander with Jefferies.

George D'Angelo - Jefferies LLC, Research Division

This is actually George D'Angelo on for Laurence. Can you guys please give me an update on pet order trends, and if there's any regulatory activity that could accelerate demand in the next year or 2?

Thomas D. Malkoski

In terms of the current level of activity in pet from a development standpoint, it's fairly strong. We have several products that are being introduced into the marketplace as we speak, so either in the last 2 or 3 months or in this first quarter of the year. In terms of new regulatory, as it relates to the food safety requirements that we expect will be implemented, we think that we're in very good position to be able to capitalize on those opportunities.

Steven O. Cordier

And they have been taking up their sales volumes, they were at over double-digit rates in the fourth quarter.

George D'Angelo - Jefferies LLC, Research Division

Okay. And one more, if you could talk a little about order trends in the Food Ingredients segment and the degree of customers focusing on the cost savings there.

Thomas D. Malkoski

Order trends are as strong as we've seen in the last 4 quarters, and the level of activity right now is split closer to 50-50 between new product -- performance-based new products and cost reduction opportunities.

Operator

And our next question comes from the line of Conner McMahon with Sidoti & Company.

Conner McMahon - Sidoti & Company, LLC

Could you just break down the sales in the industrial segment? If you could do that or you couldn't, whether that be percentage-wise or core industrial, ethanol and bio-product?

Steven O. Cordier

If you're looking at the growth rate in the business or you're looking for just the breakdown of the products as a percent of total? Or how...

Conner McMahon - Sidoti & Company, LLC

Yes. Your percentage of the total will be fine.

Steven O. Cordier

Okay, fine. Core products are about 20% of the revenue base. And our specialty products are, at this point, they're about almost 20%. And the remainder is in what we call -- you would call core industrial products.

Conner McMahon - Sidoti & Company, LLC

Okay, and that would include ethanol?

Steven O. Cordier

I'm sorry, ethanol is about 30%. So then the remainder would be into the core industrial starches.

Conner McMahon - Sidoti & Company, LLC

Okay. And are we happy with that product mix on the industrial segment?

Thomas D. Malkoski

Certainly, our strategic design here is to grow the specialty side of our business dramatically. And also, as we've noted before, we manufacture several different modified food products in our Cedar Rapids facility. And as our food business in those areas grows, we'll continue to take the material balance away from either low-value starches or ethanol.

Conner McMahon - Sidoti & Company, LLC

Okay. And for the specialty food segment, are we seeing more recurring orders? Or is that new customers?

Thomas D. Malkoski

The level of growth in food is generally a little over 2/3 of it from new business and roughly 1/3 from sustaining customers. And we have seen fairly modest, but consistent growth in a lot of our sustaining customers, which appears to be a little bit better than the population growth.

Conner McMahon - Sidoti & Company, LLC

Okay. I'm not sure if you said it or not, where do we end up with inventories for the year? I know they decreased a bit because the corn bugs. Do you have a number on that one?

Steven O. Cordier

Yes, sure. Give me a second. Total inventories were $34 million compared to a prior year of $44 million.

Conner McMahon - Sidoti & Company, LLC

Okay. All right. And we definitely see corn prices stabilizing here, and that's definitely going to affect the cost of sales next year, correct?

Steven O. Cordier

Yes, absolutely.

Operator

[Operator Instructions] Our next question comes from the line of Frank Rango with Purchase Capital.

Frank F. Rango - BKF Asset Management, Inc.

On the latex, Tom, you said 25% growth, which is a higher number than I'd heard previously. Was that sequentially or was that year-over-year? And can you explain exactly why you had a nice bump-up this quarter in latex?

Thomas D. Malkoski

It isn't just latex. Latex is a component of our specialty products. Our specialty products include some highly modified, very specialized starches that go into certain parts of paper and packaging, as well as the bio-products. And so when I speak of the industrial specialty products, I'm talking about the whole category of those, that mix of products.

Frank F. Rango - BKF Asset Management, Inc.

Okay, got it. So the bio-latex, how big an increment was that?

Thomas D. Malkoski

It is growing and we're not prepared to disclose the size of it at this time. And we have several trials going on that I'm sure we'll be talking more about it this year.

Frank F. Rango - BKF Asset Management, Inc.

Okay. And I just wanted to get a little bit better understanding of the results in the industrial, why the operations were pretty bad. Was it akin to an inventory loss? I mean, what was it? Corn prices are down year-over-year, and yet you still had down results year-over-year. And I'm just trying to understand that a little bit better. Was it just that there were timing issues with regards to you got caught with long inventory? Or how did that work?

Steven O. Cordier

No. As you just heard on the previous question, our inventories were down. What you'd look at is in the fourth quarter. And if you compare our fourth quarter total corn prices, which would include the Chicago Board of Trade plus the premiums that companies are paying to get the physical corn in from the farmers, they were never higher than they've been at that point. The premium was averaging in the fourth quarter between $1 and $1.50 per bushel. The previous high in the last half century has been probably around the level of $0.30 to $0.40 per bushel. When you look at the all-in cost for corn for the fourth quarter in the area, in the region, it was approaching $6.75 per bushel, again, an unprecedented level. And that's because it was the third consecutive year where the outgoing corn crop was short, and it drove those corn prices to absolutely unprecedented levels. And while that's coming down right now, the corn prices have fallen almost 30% to 35% from those high peaks, that's because the new crop that's being harvested today is at quite robust levels. And so there's a sufficient amount of supply projected for the next fiscal year. But that fourth quarter period, as you've heard from many of our peer wet milling companies in their earnings releases over the last couple of weeks, penalized all producers of corn products.

Operator

And our next question comes from the line of Tom Spiro with Spiro Capital Management.

Tom Spiro

Question one. Speaking with industrial, Tom, if I heard your commentary correctly, I think it was your remark, the volumes for our cornstarch, the sales into paper industry in Q4 were down 7%. Did I get that right?

Thomas D. Malkoski

That's correct.

Tom Spiro

Where do we stand as we move into the new year? What's driving it? What are your thoughts about the volumes going into the paper industry?

Thomas D. Malkoski

Part of the -- well, the broad question is that we expect that we'll continue to see modest declines in the paper industry in terms of demand for paper and packaging products, probably in the 2% to 4% range, but that's in our plan. Some of the effect of the fourth quarter relates to closures that occurred or were announced some time during the year, but actually took effect during the quarter. And the closures themselves that affected our business in particular, accounted for virtually all of that shortfall in the fourth quarter.

Tom Spiro

And can you give us your early sense of pricing? I know you're in the midst of discussions, but you typically give us a flavor.

Thomas D. Malkoski

Well, what we're seeing so far is relatively stable pricing. And I think there's a relative balance with, particularly, corn wet millers in terms of the product outputs and the choices that they have related to high fructose and ethanol and other products. And we're not seeing much movement in any of the major product categories, either for us or generally in market conditions.

Tom Spiro

I've read a number of suggestions that the fructose syrup market has been sluggish and is expected to stay sluggish or even worsen. Is that your view of it?

Thomas D. Malkoski

That is our view. And yet, with the very sharp decline in corn prices, high fructose corn syrup, as a choice between that and sugar, is -- remain very competitive.

Tom Spiro

That's helpful. Over on the food side, our gross margin in the quarter, I think, was about 32%, which is rather high. Is this a kind of a sustainable level? Or were there a couple of new products and such that spiked it up 1 point or 2, and we should see a drift back down?

Thomas D. Malkoski

I think the latter. And generally, because we did have the introduction of a couple of new products that were in some high-margin areas, and they would show up as affecting the margin by about what you speculated, 1 point or 2.

Tom Spiro

I see. I noticed our R&D expenses for the year was essentially flat to the prior year. As I recall on a number of prior calls, you suggested it might grow in the year, just concluded by about 9% or so. It did not. What happened?

Thomas D. Malkoski

Well, there were some expenses that, at one point, we thought might be categorized as R&D, and they turned out to be operating expenses. So generally, the level of investment is higher and we expect it will be in the coming year as well.

Tom Spiro

What do you think it will grow in the new fiscal year?

Thomas D. Malkoski

I think it'll be more than 10%.

Tom Spiro

I see. Also, CapEx, I see came in the 12-ish range. We had thought over the last couple of quarters that it might hit to $15 million or so. That seemed a bit weak, why?

Steven O. Cordier

It's actually -- the spend was actually closer to $14 million, $14.5 million. But if you recall, I mentioned there was a $2 million, $2.1 million of credit that we applied, that was a collection of a litigation claim against the vendor. So that offsets by the same amount the actual spend. So it's just bookkeeping.

Operator

And it seems we have no further questions at this time. I would like to turn the floor back over for closing comments.

Steven O. Cordier

Take you very much. If you have any following up questions, you can reach me, Steve Cordier, at the number on the press release.

Operator

Ladies and gentlemen, this concludes today's teleconference. You may disconnect your lines at this time. And thank you for your participation.

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