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Penford (NASDAQ:PENX)

Q1 2014 Earnings Call

January 09, 2014 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

Tom Spiro

Operator

Greetings, and welcome to the Penford Corporation's Fiscal Year 2014 First Quarter Results Conference Call. [Operator Instructions] As a reminder, this conference is being recorded. I would now like to turn the conference over to your host, Mr. Steve Cordier. Thank you, Mr. Cordier, you may begin.

Steven O. Cordier

Thank you. Good morning, everyone. Thank you for joining our conference call to discuss Penford Corporation's first quarter 2014 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 first quarter fiscal 2014. Consolidated sales for the first quarter decreased 7.4% from the previous year to $109.3 million, as lower corn prices reduced by-product revenues, affected pass-through provisions to paper industry customers and impacted ethanol market prices in the industrial business.

Volumes and unit prices net of agricultural inputs rose in both divisions from a year ago. Gross margin declined in the first quarter as the cost of corn fell at a slower rate and revenue concessions given to industrial customers using input formula contracts. We are in the business of processing corn into starch and need a certain amount of supply on hand at any point to meet booked customer orders. This meant that we absorbed high input costs as relatively expensive corn procured prior to the new harvest crops supplies was inventoried and then processed throughout the quarter.

Pass-through provisions with paper industry customers, in particular, allowed them to realize price declines at a faster pace than our raw material cost decrease.

As mentioned earlier, the corn price changes impacted revenue, as well as squeezing margins. We do not anticipate this type of sharp price fluctuations in the corn market in the foreseeable future. Forward corn and coproduct prices have stabilized, and basis levels are falling toward normalized levels. We expect Industrial segment gross margins as a percent of sales to improve from low-single digits in the first quarter toward high-single digits at the end of this fiscal year, and then continue to expand as our strategy to move to a mix of higher margin products is executed.

Net income was $500,000 compared to $1.7 million in the first quarter of fiscal 2013, and diluted earnings per share was $0.04 versus $0.14 per share last year.

Business conditions continue to improve over our fourth quarter horizon compared with the same period 12 months earlier with sales, up 3%; EBITDA, 18% higher; debt down by 16%; and net income of $2.8 million versus a loss of $8.5 million in that prior period.

Interest expense continued to decline as debt outstanding fell during the quarter. Interest expense was $800,000 in the first quarter of fiscal 2014 compared with $1.1 million in the same period last year.

The company's effective income tax rate was 41.6% for the quarter ended November 30, 2013. The tax rate exceeded the federal statutory rate primarily because of the effect of state income taxes.

Operations generated $8.7 million of cash during the first quarter, an increase of $1.8 million compared to cash generated of $6.9 million in the same period last year, mainly due to lower working capital requirements.

Capital spending for the first quarter of 2014 was $2 million, and the company expects the total capital spending for the year will be in the $15 million to $18 million range.

The company's balance sheet remains strong, with total debt of $70.1 million, falling by $2.8 million from August 31, 2013, and $13.2 million lower than a year ago.

At November 30, 2013, the debt-to-invested capital ratio was 46%, down from 47% at August 31 and from 55% a year ago.

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

Thomas D. Malkoski

Thank you, Steve. Revenue in our Industrial Ingredients business declined by 11% to $80.6 million in the first quarter. The $9.8 million drop in revenue was directly tied to lower values of corn input costs just reviewed by Steve.

By-product revenue, which is closely related to corn prices, declined by 35% or $8.2 million. Lower corn cost pass-through to certain starch customers further reduced revenue from last year's first quarter. The combination of these 2 factors explains the entire revenue decline in the industrial business.

Industrial Ingredients recorded an operating loss of $2 million in the first quarter of fiscal 2014 from an operating income of $1.4 million in the same quarter last year. Lower selling prices for starch, ethanol and by-products outpaced the decline in corn cost.

Specialty products, unit pricing held steady versus a year ago. Industrial specialty products revenue rose by 8% during the first quarter and began commercialization of 2 new specialty products. The first is a line of high-performance cationic polymers for increased strength and packaging. These natural polymers allow customers to achieve targeted strength while reducing manufacturing cost. Cost benefits include the use of less expensive raw materials, lower basis weight for the packaging and faster machine run rates, since our products help drain water from the process away more quickly.

The second product is a novel bio-product that addresses anti-blocking adhesion and print resolution requirements for certain paperboard customers. We are now shipping commercial orders to 8 specialty packaging mill locations for this new product.

The Food Ingredients business continues to perform well, recording record quarterly sales of $28.7 million, an increase of 3.6% over a year ago. Strong growth in gluten-free pet products, dairy, sauces and bakery more than offset a decline in coating revenue.

Operating income expanded by 22% to $6.5 million from changes in the product mix and lower unit cost, partly due to process improvement initiatives implemented since last year.

That concludes our prepared remarks. Please open the call for questions.

Question-and-Answer Session

Operator

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

George D'Angelo - Jefferies LLC, Research Division

This is actually George D'Angelo in for Laurence today. For Food Ingredients, can you give a little bit more detail on gluten-free and pet products mix for the quarter?

Steven O. Cordier

What would you like? What kind of detail would you be seeking?

George D'Angelo - Jefferies LLC, Research Division

Just like what kind of run rate you're seeing in those categories?

Steven O. Cordier

Yes, we're looking at, obviously, an increasing run rate in all of those product categories. We label those our targeted growth group category within the food industrial business, and we're seeing strong trends in that entire group across that category. The gluten-free and the pet categories certainly conform part of that. And we're seeing not only a good existing business activity, but a strong pipeline of new product capabilities going forward.

Thomas D. Malkoski

Right. We're seeing, depending on the quarter, some of the growth is what I'd call lumpy, but it ranges anywhere from 10% to 25% growth in a given quarter for those product categories.

George D'Angelo - Jefferies LLC, Research Division

Okay. And then one more, this is a little bit -- so General Mills recently announced they're going to market a line of GMO-free Cheerios, which I'm guessing you guys saw that news. Is this any type of opportunity for your, guys, Food Ingredients business?

Thomas D. Malkoski

Well, that specific one, I'm not sure. The move toward...

George D'Angelo - Jefferies LLC, Research Division

The trend, I mean.

Thomas D. Malkoski

Yes, the move towards GMO-free for a lot of our customers, there are many products that we offer that are GMO-free. And we have recently developed a new fiber product that is a non-GMO white corn-based product. And we offer several that you might imagine that anything potato and rice would be, in most cases, GMO-free.

Operator

[Operator Instructions] Our next question is coming from Conner McMahon from Sidoti & Company.

Conner McMahon - Sidoti & Company, LLC

Could you break down the Food segment in terms of percentages for me?

Steven O. Cordier

As a percent of revenue?

Conner McMahon - Sidoti & Company, LLC

Correct, of Food revenue.

Thomas D. Malkoski

I think we want to be careful for competitive reasons, but one thing that we have talked about in the past is the breaking out the coating segment from the rest of our segments. And coatings represents roughly 35% of the foods revenues. And the revenues in coatings have been down slightly from a year ago in previous quarters, and some of that is related to a customer promotional product that continues in the stores at this point. But virtually, across all of the other food categories, we're seeing some pretty attractive growth.

Conner McMahon - Sidoti & Company, LLC

Okay. Do you think gluten products or pet products is the bigger growth opportunity here?

Thomas D. Malkoski

Well, I think they're both very significant growth opportunities. I would see that the opportunity for unique products would be more likely greater in the pet side. But the -- some of the volume opportunities in gluten-free could be very significant, particularly as you get to some of the private label and some of the larger restaurants that are still trying to find a way to get gluten-free offerings into their menu.

Steven O. Cordier

There are 2 very attractive but slightly different aspects to those markets. One is that the pet or companion animal market is already a huge and established market that is appealing for entry, while the gluten-free is a market that's been growing rapidly over the last several years. So from a perspective of an ingredient supplier, both are attractive for different reasons.

Thomas D. Malkoski

Well, and I'll follow on from Steve that, remember that a lot of the products that we offer in our pet products platform do have Health & Wellness attributes to them, and we offer products that are also gluten-free within the pet segment. And most of the consumer interest in Health & Wellness related to pet -- companion pet products parallels what you see in humans. And so we're finding that as a very consistent market for opportunity.

Conner McMahon - Sidoti & Company, LLC

Okay, great. Now in terms of paying down debt the next year, should we expect similar to what we saw over the last 12 months?

Steven O. Cordier

Well, our capability of paying down debt is about that. Remember, too, though, that we do intend to spend money on capital and accelerate the expansion of the business into a margin that reflects higher -- mix of higher-margin products. And if we have opportunities for external expenditures for bolt-on acquisitions or other partnerships that we might invest in, those would be uses of cash as well. But absent those kind of things, which we do think will accelerate our strategy, we would pay down debt.

Thomas D. Malkoski

Over the past 3 years, the capital expenditures have paralleled debt support of growing in some of these specialized product categories. So a very significant proportion of capital has been allocated towards some of these new growth areas. And it does show up in our business. So it doesn't happen overnight, but the percentage of our business that we categorize is our specialty businesses, so our food, our cationic line of product in Industrial and our bio-products, has now grown to over 40% of the revenues for the company. And that's a significant improvement year-on-year, but it also, compared to 3 years ago, it's a very significant move.

Conner McMahon - Sidoti & Company, LLC

Okay. And finally, just a general question, what's your outlook for corn prices in 2014?

Steven O. Cordier

It's basically fairly stable. The corn harvest has been robust. The inventory and carryout that normally -- that's been over the last 2 or 3 years with poor corn harvest in the preceding years is now robust, and that should act to stabilize, not only in the corn prices on the Chicago Mercantile deal exchange, but premium or discount, which we call the basis required to buy that corn on a physical basis from farmers, should also decrease to more normalized levels, which, in our processing area, is around flat to the CME.

Operator

[Operator Instructions] Our next question comes from Tom Spiro from Spiro Capital Management.

Tom Spiro

Question number one, just curious, the very cold weather that we've all had over last few days, whether that had any impact on your operations, on your manufacturing or your ability to source corn or deliver product, that sort of thing?

Thomas D. Malkoski

Tom, it had a minor effect for about 1.5 days on some ethanol operations, just from some freezing up of mines. And then a minor effect on logistics of availability of railcars for a couple of days when it was really so cold. It was hard to get them moved around, not just near our facility, but within the Midwest region.

Tom Spiro

Sounds like it's not a particularly big deal, then? That's understandable.

Thomas D. Malkoski

No, I don't think it's going to continue either because we're seeing warmer weather hit.

Tom Spiro

Sure. Question two, as I would look at the R&D number, and it looked a little light to me. In fact, it looked a little light the last several quarters, Tom. And I was curious whether my perception is just wrong or if something else is going on?

Thomas D. Malkoski

No, we -- as I talked about last year or, actually, the last 4 or 5 quarters, we really stepped up to port of third-party testing of certain new products. And a lot of those tests were concluded during the last fiscal year or, actually, in the last maybe 5 quarters. But those tests actually helped form the basis for the competitive positioning for our products and the whole value proposition that we bring to many of our customers. So I would expect to see that start to pick up again because some of the other new products in the pipeline are also going through what I call third-party testing for validation.

Tom Spiro

That's helpful. Tom, I'd also ask you what your sense is of the corn wet millings industry's capacity utilization rate. How is the industry doing these days in your judgment?

Thomas D. Malkoski

Well, the capacity utilization remains very high. I think it remains to be seen how the [indiscernible] side in the market will shake out. And it does remain to be seen also how ethanol will play out in the coming quarters. But right now, the market for ethanol remains especially tight and pretty strong, and it's largely driven by the relative low value of corn input cost today on a world market, making the U.S. a very strong exporter for ethanol-based products.

Tom Spiro

Are we operating Cedar Rapids at full capacity?

Thomas D. Malkoski

Yes.

Tom Spiro

Usually, on this call, Tom, you can give us a sense of how the pricing discussions have proceeded with respect to our cornstarch products. What do you think?

Thomas D. Malkoski

Pricing is relatively flat year-on-year. Some products are up, some customers are up, some were down, but I would say on average, it's relatively flat.

Operator

We've reached the end of our question-and-answer session. I'd like to turn the floor back over to management for any further closing comments.

Steven O. Cordier

Thanks very much for your participation. If you have any follow-up calls, you can reach me, Steve Cordier, at the number on the top of the earnings release.

Operator

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

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