Imperial Sugar Company F2Q08 (Qtr End 03/31/08) Earnings Call Transcript

Imperial Sugar Company (IPSU)

F2Q08 Earnings Call Transcript

May 12, 2008 2:00 pm ET

Executives

Courtney [McCaslin] – Assistant General Counsel

John Sheptor – President, Chief Executive Officer

Hal Mechler – Chief Financial Officer

Analysts

Hamed Chorsand – BWS

Jonathan Lichter – Sidoti & Company

[Marty Comber] – [Nord] Partners

Bob [Sares] – [L&K Capital Management]

Ross Taylor – [Chase Hill Capital]

Presentation

Operator

Welcome to the Imperial Sugar second quarter 2008 earnings conference call. (Operator instructions) I would now like to turn the presentation over to your host for today’s call, Ms. Courtney [McCaslin].

Courtney [McCaslin]

Good afternoon, I’m Courtney [McCaslin], Assistant General Counsel for the company and joining me on the call are John Sheptor, our President and CEO and Hal Mechler our Chief Financial Officer.

Our conference call today to discuss results for the second fiscal quarter of 2008 is being transmitted live over the web and is being recorded and this replay will be available through close of business June 12, 2008, but all information is current as of today, May 12, 2008. Any recording or other use of this live transmission or audio replay is not allowed without the prior written permission of Imperial Sugar.

The earnings press release issued this morning; our form 10-Q for the first and second fiscal quarters of 2008 and our form 10-K for the year ended September 30, 2007 are available on the shareholder relations section of our website at ImperialSugar.com.

Today’s discussion and responses to questions may contain forward-looking statements that represent management’s expectations and beliefs concerning future goals and performance by Imperial Sugar and are based on information available to us as of today and involve risks and uncertainties that could lead to actual results different from management’s expectations.

Some of these business risks and uncertainties are listed on our SEC filings and we urge you to consult those documents. At this point I’ll turn the call over to John Sheptor, our President and CEO.

John Sheptor

As you know, we experienced an industrial accident at our Port Wentworth facility in February. Our refinery sustained limited damage but our packaging facility was completely destroyed in the incident.

We extend our sympathies to those families who were affected with the loss of loved ones. The broader Savannah community has been remarkable in how they have embraced our families with aid, support and compassion. I extend my sincere gratitude to all of you and all those who have personally helped or made donations to the relieve fund that has now surpassed $1.2 million.

I thank everyone who has supported our families, patiently given us time to plot our course forward and helped us to meet our contractual obligations. Your assistance in our time of need will never be forgotten.

The company’s financial posture has been conservative during recent years and as a result, our balance sheet is strong. We expect that our cash reserves and insurance coverage will be sufficient to enable us to recover from this event. The dedication and talent of our employees coupled with our financial strength positions us well for the challenges we currently face.

We have a heritage of resilience and we intend to continue as a premier producer of sugar products. The Board of Directors has reviewed numerous scenarios regarding possible directions for our company and authorized management to contract engineering services to augment our internal team as we complete the design of our new packaging facility.

Demolition is well underway and specialty sugar production should begin again this summer. Repairs to our refinery should be completed this fall and operations should be restored by year-end. Long lead-time equipment for our packaging facility is being procured and we expect to be fully operational by midsummer 2009.

Over 75% of our Port Wentworth employees have been recalled to work and are engaged in rebuilding and shipping activities. Our Gramercy plant has performed superbly during this critical time, producing more than 10% above their plant volumes, sustaining capacity output.

Our Mexican joint venture partners, the Santos Group has aided us with coordinating supplies from Mexico and our sales team has worked diligently to collaborate with our customers to meet their needs.

The Port Wentworth incident has elevated the inquiry into the hazards of combustible dust. In that respect, information is being exchanged freely between producers and we are cooperating with regulators to support the development of recommendations based on investigative findings and scientific studies.

Investigations continue throughout the industry as well as at both of our facilities. We expect OSHA will issue reports in the upcoming months. Let me make a few comments regarding the overall market conditions.

The market has largely been able to absorb the loss of our capacity due to its oversupplied condition on both sides of the border. Industrial and food services prices have moved somewhat higher and equalized with Mexico imports, as you would expect under NAFTA.

Imperial has not participated in any significant way in this upward trend, however, as we continue to fulfill contracts established during the market downturn. Recent USDA planting forecasts indicate an 11% reduction in beet acreage as farms switch to higher value crops, which combined with the inventory depletion associated with our event, should tighten the market in 2009.

We see this as a strong signal that market conditions leading to the price erosion of the past year has begun to reverse. Market prices in Mexico continue to be depressed versus their historical levels due to high inventories. Most Mexican producers are selling only what they need to in order to meet the cash requirement of the current harvest.

Exports to the US are only modestly higher than last year. We have sustained our US market share in branded retail through excellent coordination between our production, sales and broker teams. I again thank our customers and loyal consumers for supporting our brand during this recovery period.

Market questions regarding the LSCPI Cargill refinery persist. The lack of real construction activity or confirmation of financing continues to raise doubt within the industry. Regardless, we take this potential market entry seriously and we are developing alternative sources of raw sugar for our Gramercy facility.

We are working with our partners in Mexico, foreign quota suppliers and domestic sources to replace LSCPI as our principal supplier. We continue to forge ahead with our cost improvement and growth initiative. Productivity improvements at our Gramercy facility are already delivering results.

Lean, six sigma and TPM principles will continue to be implemented in Gramercy and will be built into our Port Wentworth startups during the coming months. Beyond our base domestic sugar business, we look to our premier wholesome brand in the organic and natural channel as a key platform for future development.

Our joint venture in Mexico has performed well during its first six months of operation and we aspire with our partners to expand its market reach. Product development initiatives for the US market have progressed substantially and we are pleased with their potential.

I look forward to sharing more details with you in future quarters. Hal will now review our financial results for our second quarter. Expenditures related to Port Wentworth have outpaced recognized insurance recoveries, expanding our reported losses.

The second quarter is historically our weakest quarter, and the erosion of prices that we have spoken of during recent quarters would have led to a small loss for the quarter, even without the costs associated with Port Wentworth. Hall will provide an overview of our reported results and elaborate on our insurance claims process. Following his comments, we will open the line to questions.

Hal Mechler

I’m going to provide a brief summary of our results for the quarter today and then discuss some of the issues surrounding Port Wentworth and the impact on operations in our financials. There is of course more detail in the 10-Q that we filed today, so please reference that filing as well.

As you all know, our second quarter fiscal 2008 operations include the Port Wentworth tragedy, which impacted results across the board significantly. This quarter’s operating results were largely driven by three factors: costs related to the event, restricted production volumes resulting in sales reductions and price induced margin restrictions.

Our reported net loss for the second quarter was $15.5 million or $1.33 per share. This compares to net income last year of $8.7 million or $0.74 per share. Those results include a $12.1 million pretax charge related to the explosion fire that occurred in February at Port Wentworth.

The charge itself is comprised of property impairment, inventory write offs and other costs totaling $28 million, offset with $15.9 million of property insurance recoveries recognized. We did not recognize any amounts for business interruption insurance this quarter.

I should point out here that we do anticipate additional insurance recoveries in coming quarters, however $15.5 million is what we were allowed under GAAP to recognize this quarter. I’ll have further comments about the insurance accounting process in a moment.

Sales for the second quarter declined to $145 million which is down from $213 million in the same period last year. Given that Port Wentworth was not operational for two-thirds of the quarter, sugar production and sales volumes were down significantly. Increased production at the Gramercy refinery provided some offsets, but sales volumes were down 27% for the quarter.

I should also mention that the company declared a force majeure on its contracts sourced at the Port Wentworth refinery and is allocating product from excess available production to customers under those contracts.

Lower pricing from the continuation of an oversupplied domestic industry combined with higher energy and transportation costs caused our gross margin to fall from around 10% last year to 2% in the current quarter. I should mention that these gross margin amounts are after deducting depreciation.

Our gross margin discussions in prior presentations were before deducting depreciation. We have provided comparable quarterly data for past quarters on our investor website to help you out there.

Higher energy costs were the result primarily of an unfavorable fuel mix during the quarter due to decreased production activity at Port Wentworth. That facility uses primarily lower priced coal as its energy source, while Gramercy uses higher cost natural gas.

Our SG&A line showed improvement as it decreased almost $3 million due to lower corporate development, legal and advertising costs. Our expected annual tax rate for this year is 36.5%, higher than last year primarily because of lower tax-free interest. In terms of our liquidity, our cash and temporary investments balance at quarter end was $86 million and our bank agreement provides loans up to $100 million which was undrawn at quarter end. Its availability has been unaffected by recent events.

I do want to add a few comments about insurance accounting. The pronouncements can be a bit confusing but are important to understanding our current results. You’ll see from a commentary in the 10-Q, but basically there are several buckets for insurance recoveries.

The accountants talk about probably, possible and remote. The evaluation of those insurance recoveries obviously requires us to make some judgments about future results which affect the timing of the reported amounts. Insurance recoveries that are deemed probably and reasonable estimatable are recognized to the extent of their related loss.

We had $15.9 million of such recoveries deemed probable at March 31. And again that is the amount of property insurance recovery we reported in the press release and the Q as an offset to the overall charges to the earnings for the second quarter.

Recoveries which are deemed possible have been disclosed in the Q, but will not be recognized, that is recorded as credits in the income statement until they are probable. We estimate that the possible unrecorded recoveries are between $5 to $7 million.

Finally, insurance recoveries which result in gains, including recoveries under business interruption coverage, are recognized only when realized by settlement with the insurers. Business interruption recoveries for the second quarter are estimated to be between $6 to $7 million. We expect some amounts of business interruption recoveries to be settled and recognized as we work through monthly claims in future quarters.

Advanced on insurance settlements are recorded as offsets to the accrued probable recoveries. We received $14 million in advances in March and another $17.5 million of advances in April and May of this year. I realize this can be a bit confusing and I’m happy to try and answer your questions that you might have on this subject.

Again I encourage you to review the information provided in our form 10-Q, particularly in MD&A. Also we have posted additional supplemental financial information that may be meaningful to our investors on our website, www.ImperialSugar.com. That concludes my remarks. Operator, would you like to open up the line for questions please?

Question-and-Answer Session

Operator

(Operator instructions) Your first question comes from Hamed Chorsand – BWS.

Hamed Chorsand – BWS

Regarding the business as it is right now at Gramercy, how is that affecting from an operational standpoint when you’re running at full capacity, is there any risks that you’re taking on right now when you’re saying that production is higher than you were expecting?

John Sheptor

The operations that we’re currently running at Gramercy are consistent with what we did in the period post-Katrina. We’re running at 19 and 2 schedule that gives employees as well as an opportunity to conduct maintenance. And we are completely confident that the operations that we’re currently managing at the Gramercy plant are safe and within manageable risk.

Hamed Chorsand – BWS

How much of a benefit are you seeing from the imported sugar coming from Mexico?

Hal Mechler

We have sugar that just started flowing from Mexico at the very end of the quarter. It is in total the current plan is about the equivalent of one month’s production at Savannah and it allows us to service some industrial contracts that we would otherwise have difficulty servicing with existing production and to make sure that those customers have sugar to sustain their operations. So that’s where we’ve focused and prioritized things and Mexico was obviously one of the first places we looked.

Hamed Chorsand – BWS

Is that sugar being refined a second time over after being imported from Mexico or is that good quality that you think that meets your [inaudible].

Hal Mechler

It is refined sugar as its coming in; it does not need to be re-refined. Some of it is going into liquid applications at liquid stations domestically, but it is fully refined sugar.

Operator

Your next question comes from Jonathan Lichter – Sidoti & Company.

Jonathan Lichter – Sidoti & Company

I missed some of the beginning comments, how confident are you in the timeline that you’ve provided for the recovery.

John Sheptor

The timelines that we have provided are based on our most recent engineering assessment. There are always the potential for unforeseen delays in a project of this scale, but we do believe that we’re doing our best to accurately forecast when these operations will be back in service.

Jonathan Lichter – Sidoti & Company

Have you already procured the packaging equipment from suppliers?

John Sheptor

Many of the long lead-time packaging equipment have been purchased. Others are in the process of being procured as we speak.

Jonathan Lichter – Sidoti & Company

Are you currently buying sugar from competitors to meet contracts?

Hal Mechler

We’ve purchased small amounts of sugar from competitors, including exercising our option that you’ll recall, we disclosed relative to the Southern Minnesota transaction from two years ago or a year and a half ago. So we are purchasing some sugar from outside but not large quantities, other than the Southern Minnesota purchase.

Jonathan Lichter – Sidoti & Company

How are customers, are you able to talk about doing contracts for the next year, given the uncertainty, how are customers responding?

John Sheptor

There have been limited contracts for 2009 that have been issued. We are bidding responsibly on those contracts given our estimated time of restart. At this point we do expect to be granted some amount of contracts for the 2009 season.

Operator

Your next question comes from [Marty Comber] – [Nord] Partners.

[Marty Comber] – [Nord] Partners

You mentioned the beet crop acreage will be down about 11% year over year, I was wondering what you’re hearing about the farmers planting genetically modified beets this season and what kind of impact that may have on yields?

John Sheptor

We have, as you have heard, that the number of acres for genetically modified sugar beets is up year over year. It’s still yet to be determined what type of yield improvement or enhancement they will receive. That is certainly dependent upon disease pressure as well as weather conditions. After we get through this crop season, I think all of us will have a better idea of what impact that will have ultimately on the production yield on beet acres.

[Marty Comber] – [Nord] Partners

And with regard to the packaging facility, I may have missed this earlier on, what is the estimated cost going to be to get the facility up and running 100%?

Hal Mechler

We’ve estimated the cost could be between $180 million and $230 million for the packaging facility as well as to repair the limited damage in the refinery and rebuild the silos.

[Marty Comber] – [Nord] Partners

And legal costs going forward, down this quarter, how should we model it on a going forward basis for the next couple of quarters?

Hal Mechler

The legal costs in SG&A were driven up last year because we were in the final stages of the Southern Min. arbitration process. That’s the primary SG&A driver.

[Marty Comber] – [Nord] Partners

And going forward, do you expect these kind of levels?

Hal Mechler

With regard to what’s in SG&A, now understand there is legal fees also in the event charge, the $12.1 million.

Operator

Your next question comes from Bob [Sares] – [L&K] Capital Management.

Bob [Sares] – [L&K] Capital Management

How should we model the refinery event on an ongoing basis where you will continue to have legal and other costs roll through that section of the P&L?

Hal Mechler

Difficult to give you much guidance there to be honest with you. I think it’s a fair statement to say that the cost in the first couple of periods in the aggregate certainly are heavier than they will be on a run rate basis, I think that’s a reasonable assumption.

But beyond, and there are some things in those charges as you look at the discussion in the footnote to the 10-Q that reasonably clearly early event costs as opposed to ongoing. As far as some of the other costs, it’s very difficult for us to project and to give you much guidance in there.

Bob [Sares] – [L&K] Capital Management

Can you give us a little bit of insight into your thinking with respect to the refined sugar market dynamics? It strikes me that when your plant comes back online in 2009 it will be intersecting with the likely opening of the Cargill plant and it seems like that has a chance of throwing the supply side of refined sugar a little bit of out of bounds of what’s required. And I’m curious how the management team and the Board are thinking through that.

John Sheptor

Just for clarification, the LSCPI Cargill facility, if it is built, is not planned to be online until the middle of 2010, which would be one year after our restart. So it’s not coinciding with it. And I will reinforce there is significant doubt still in the marketplace whether that refinery will every come online.

Having said that, we are working diligently to provide alternate supplies of raw sugar for our Gramercy facility if it comes to that. The marketplace is already responding to the depressed sugar prices that we’ve seen over the last year with the reduction of beet acres and we believe that the market will adjust accordingly depending on how much demand versus supply exists at any period along the way, whether that is 2009 or 2010.

Bob [Sares] – [L&K] Capital Management

Would there be other sources of available raw side of Mexico for the Wentworth plant given the current farming regulations that control the flow of raw sugar?

Hal Mechler

The Port Wentworth plant currently is supplied almost exclusively by offshore-allowed imports. So it currently is supplied not by domestic source. The Gramercy plant in Louisiana is supplied almost exclusively by Louisiana grown domestic cane.

Bob [Sares] – [L&K] Capital Management

Right, then so the Gramercy plant would really the primary alternative to Louisiana cane is Mexico?

John Sheptor

The Gramercy plant going forward can be supplied by Mexico in part, depending on what the supply demand dynamics are in the US. It can be supplied by increases in the quota allowed by the Federal government and or supplied by other raw sugar sources in the US.

Operator

Your last question comes from Ross Taylor – [Chase] Hill Capital.

Ross Taylor – [Chase] Hill Capital

I’m trying to get a little better understanding of how you expect capacity coming back on, what kind of schedule, when do we get back up to effectively full capacity? Do you increase capacity in this process, is that an opportunity?

John Sheptor

At this point, the design plan is to rebuild the Port Wentworth facility at its nameplate capacity that existed prior to the explosion. The plant will restart in stages as different parts of the facility are either repaired or reconstructed.

The first restart will be this summer with our specialty sugar operations at the Port Wentworth facility that includes co-crystallized flavored sugars for the specialties market. As we go into the fall, when the refinery restarts, we will be operating at that time a facility that will be exclusively dedicated to the industrial marketplace. We will not be at full capacity in the refinery until the silos are reconstructed because we will be limited in storage capacity.

And the silos should be completed in the early part of the spring, allowing us to be able to service at full capacity the industrial marketplace. Different lines within the packaging facility will come online through the spring and by the middle of the summer next year, will be at full capacity for the refinery.

Ross Taylor – [Chase] Hill Capital

There’s obviously a big debate going on in the US about energy policy and how corn based ethanol is potentially a significant contributor to corn inflation and to food inflation and the like. The Brazilian history with sugar-based ethanol appears to be a radically more successful process than the US focus on corn based ethanol. Can you talk about why the US doesn’t use, why there’s no real sugar based ethanol being done in the US?

John Sheptor

Well I won’t speak on behalf of the US government in terms of policy; I will speak to you with regard to Imperial’s viewpoint in this regard. The current sugar program makes sugar a non-competitive raw material for the production of ethanol with corn even at $6.00 a bushel.

We have proposed as part of the farm bill debate that the world’s sugar should be allowed to be imported into the US for the production of non-food products, including ethanol to take some of the pressure off from the demand for corn for ethanol. That has received a significant amount of debate by parties pro and con.

And it is doubtful that that will be pursued in this farm bill. We continue to maintain, however, that that is part of a future policy with regard to enabling sufficient ethanol to meet the demand for this country.

Hal Mechler

I think the key thing to remember in that analysis is the world price of sugar is about half the domestic price of sugar. So for the alternate value of that crop in the US is much higher than the alternate value in other parts of the world, including Brazil. And so the economics of producing ethanol from that stand, that grown cane is very different in Brazil from in the US. John’s talking about the allowance or the proposal to allow world priced sugar at roughly half the cost of domestic raw sugar in ethanol production.

Ross Taylor – [Chase] Hill Capital

And so basically what you’re faced with is a situation where for some reason the US sugar market is, you won’t say it, I’ll say it, but significantly more protected than many other commodities and as a result it’s a non-competitive situation at this point.

John Sheptor

What I will say is that sugar at this time is non-competitive to corn production.

Operator

And at this time you don’t have any further questions in the queue; I will turn the call over to management for closing remarks.

John Sheptor

Well we thank you very much for joining us this afternoon. We are available to speak with you by phone afterwards if you have specific questions. Please refer to our website for additional details with regard to the Q and managerial comments. And we look forward to speaking with you again in the next quarter.

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