MGP Ingredients, Inc. (MGPI) Q1 2017 Earnings Report, Transcript and Summary

Good day, and welcome to the MGP Ingredients First Quarter 2017 Results Conference Call and Webcast. [Operator Instructions] Please note that this event is being recorded. I would now like to turn the conference over to Mr. Bob Burton, Investor Relations. Please go ahead.

Thank you, Danny. Good morning, everyone, and thank you for joining the MGP Ingredients conference call and webcast to discuss the company’s financial results for the first quarter 2017. I’m Bob Burton with Lambert, Edwards, MGP’s Investor Relations firm. And joining me are members of their management team, including Gus Griffin, President and Chief Executive Officer; and Tom Pigott, Vice President of Finance and Chief Financial Officer. We will begin the call with management’s prepared remarks and then open the call up to questions. However, before we begin today’s call, it is my responsibility to inform you that this call may involve certain forward-looking statements, such as projections of revenue, earnings and capital structure as well as statements on the plans and objectives of the company’s business. The company’s actual results could differ materially from any forward-looking statements made today due to a number of factors, including the risk factors described in the company’s most recent annual and quarterly reports filed with the Securities and Exchange Commission. The company assumes no obligation to update any forward-looking statements made during the call. If anyone does not already have a copy of the press release issued by MGP today, you can access it at the company’s website, www.mgpingredients.com. At this time, I would like to turn the call over to MGP’s President and Chief Executive Officer, Gus Griffin. Gus?

Thank you, Bob. And thank you all for joining us on this call. On this call, we will provide an overview of the quarter, updates on key financial performance metrics and a discussion of progress against our strategy. Then we will take your questions. We expect the call to run about 45 minutes. Now turning to results. We’re off to a good start in 2017, building on the momentum over the last two years. We made substantial progress against our growth strategies, particularly in growing our premium beverage alcohol business. Total net sales for the quarter increased 13.4% over last year, driven by a 15.8% increase in our Distillery Products segment. Gross profit for the quarter increased 11.7%, with both business segments showing double-digit growth. Gross margins contracted slightly, however, as pricing for DDGs, our Dried Distillers Grain co-product, mirrored a market-wide decline. Operating income also improved 6.2%, reflecting gains in gross profit that were partially offset by increased SG&A, as we increased the support for our MGP brands initiative. Looking at each segment individually. In our Distillery Products segment, total food grade alcohol sales grew by 19.5% on the strength of premium beverage alcohol. In line with our continued efforts to migrate our business away from industrial alcohol, sales of premium beverage alcohol grew by 30.4%, while sales of industrial alcohol were flat year-over-year. The growth in premium beverage alcohol reflects increased demand for both our American whiskey products and our vodka and gin offerings. Overtime, the continued shift away from industrial alcohol and towards premium beverage alcohol should provide MGP and our investors a more stable and profitable revenue stream. This quarter, premium beverage alcohol accounted for 70% of total food grade alcohol sales. By comparison, it represented 65% for the 2016 full year. While our progress may not always be linear, we remain pleased with the pace of this migration. Pricing for Dried Distillers Grain, or DDGs, was a significant drag on segment results. Sales of distillers feed and related coproducts declined 14.8%, with pricing reflecting the new supply demand dynamic created by China’s increased tariffs on imported DDGs. Despite this headwind, segment gross profit grew 11.9%, reaching $16.6 million for the quarter. As we have said in the past, we’re putting away barreled whiskey inventory for our own use. In addition to using it to support the development of our own brands, it may also be used to build strong strategic partnerships and to strengthen our market position and our ability to attract and retain new distillate customers. Due to the strong growth of the American whiskey category and the accelerated M&A activity in the industry, the demand for a widely aged whiskey has remained strong. Because of this demand, we continued, on a limited basis, to leverage sales of widely aged whiskey inventory to support our strategy of building partnerships and attracting and retaining customers for our new distillate. Our ongoing strategy is to continue to build our inventory of aged whiskey, and even with these sales, will increase the inventory by $2.3 million this quarter. Our total aged whiskey inventory, at cost, is now over $53 million. Turning to Ingredient Solutions. The segment reported expected modest sales growth on the strength of our overall starch portfolio. Quarterly revenues grew 1.7%, while gross profit grew by 10.5% to $2.4 million. Gross margins expanded 150 basis points, driven by lower input cost and improved plan efficiencies, partially offset by lower selling prices. We continue our work to take full advantage of the macro trends benefiting this segment. That concludes my initial remarks. Now let me turn things over to Tom Pigott for a review of the key metrics and numbers. Tom?

Thanks, Gus. As Gus discussed, this quarter featured stronger revenue growth than we’ve seen in several quarters and gains in gross profit, partially offset by lower levels of profit on DDG. Overall, we are pleased with the performance of the business during the quarter. For the quarter, consolidated net sales increased 13.4% to $87.2 million. Gross profit increased 11.7% to $19 million, primarily due to the higher sales of premium beverage alcohol in the Distillery Products segment. Gross margin declined by 40 basis points, driven by the unfavorable rates in DDG that Gus mentioned. While margins did decline in the quarter, it’s important to note that the strong revenue growth helped the company achieve its highest level of quarterly gross profit in recent history. We continue to invest for the future growth in SG&A to build our on branded platform. For the quarter, SG&A expense was up $1.3 million due to increase in personnel costs and advertising and promotion expenses. The strong growth profit performance contributed to a 6.2% increase in operating income for the quarter. Our ICP joint venture contributed $471,000 to this quarter’s results, down slightly from the prior quarter. Our tax rate reduced to 24.7% in the current quarter, down from 35.4% in the prior year quarter. The reduction in rate was due to the required implementation of the new accounting standard on stock compensation. Net income for first quarter increased 22.9% to $8.7 million, and earnings per share increased 22% to $0.50, both reflecting the favorable tax rate and improve performance from operations. Overall, MGP’s balance sheet remains solid, allowing us to continue to invest to grow as well as return funds to shareholders. Recently, the Board authorized our second quarter dividend in the amount of $0.04 per share. The Board’s use of dividend is an important way to share the success of the company with shareholders. Despite the headwind on DDG pricing we mentioned, MGP is in a strong position to continue to deliver on its previous guidance, except in the area of the corporate tax rate outlook, which declined to 30%. Operating income is expected to grow between 10% and 15% annually from 2016 through 2018. This guidance excludes the favorable litigation settlement and asset sale gain recorded in the third quarter of 2016. Recognizing the difficulty of projecting three years into the future, our conservative estimate of growth in operating income in 2019 is 15% to 20%, as sales of aged whiskey inventory become a more significant factor. Modest growth is expected in net sales in 2017, subject to some volatility as the company continues to shift sales from industrial to beverage alcohol. 2017 gross margins are expected to continue to grow versus 2016. The 2017 effective tax rate is forecasted to be 30% and shares outstanding are expected to be approximately 16.8 million at year-end. 2017 profitability for ICP remains exposed to the challenging and volatile conditions in the fuel ethanol industry. Now let me turn things back over to Gus for his concluding remarks.

Thanks, Tom. We are pleased with our first quarter results, and also, the progress we made against our strategic plan during the quarter. We continue to maximize the value of our production, focusing on premium beverage alcohol and migrating away from lower-margin industrial alcohol. We are excited about the macro consumer trends benefiting both of our business segments, and we continue to work to take full advantage of that. Our MGP brands initiative is still very much in its infancy, but we are pleased with our progress building both our portfolio in organization, and we are very optimistic about the long-term potential. We continue to invest to grow, progressing further on our $29 million whiskey warehouse expansion plan and putting away additional whiskey. We remain focused on our key strategies over the long term, and although we may experience quarter-to-quarter volatility, we remain confident that focusing on these strategies would drive a superior long-term shareholder returns. That concludes our prepared remarks. Operator, we are ready to begin the question-and-answer portion of the call.

Thank you. We will now begin the question-and-answer session. [Operator Instructions] And our first question comes from Bill Chappell with SunTrust. Please go ahead.

Thanks. Good morning.

Good morning.

Good morning Bill.

Just a few questions. I guess, first on premium spirits. Can you give us an idea – I assume most of that was brown versus white, but how much on that brown was just winning new – or overall, was winning new business versus just your expanded abilities of expanded distillation and warehouse capacity to actually achieve this type of growth?

Okay, I’ll take that. Bill, we don’t break down by specific product category. We don’t break down our sales, disclose that at this point. But what we can say is we saw nice growth across both brown and white, and all of our sales were very much in line with our long-term strategy.

But did the plan – I mean, is that – did it unlock – the expanded capacity unlock the ability to do this?

Yes. I mean, the – certainly having additional warehouse capacity at Lawrenceburg allows us to serve more customers for brown goods, and that’s a key driver to the revenue growth. The number of customers on brown goods continues to grow.

Yes, the – we’re seeing – we are reaching out further into the industry. I think our – the value we add and our position, the knowledge of our position, the market seems to be ever-increasing and well-received and well-understood. And new customers and existing customers alike understand that we have the capacity to grow with them as their business grows and the capabilities to meet any need to have.

Okay. And then, Tom, can you maybe give us an idea of what the DDG headwind will be this year? I mean, if that’s – I understand that you’re reiterating the full year guidance, but what kind of new headwind that might be?

Yes. What I’ll tell you, it was – in the quarter, it was 130 basis points in margin in distillery. So it was a headwind in terms of the overall margin delivery. I don’t want to forecast it out because it’s hard to project what will happen in that market, although we do expect the softness in that market to be continued throughout the year.

Yes. Bill, we’ll continue to monitor that very closely. I mean, as you may be aware, there have been tariffs in the past, but this tariff, this additional tariff, came in at January rather expectedly and made it really severe. China takes about half of the DDGs exported from the U.S. And this new tariff, essentially, shut off the China market. So the industry in total, and this – when I talk about the industry, it is beyond the beverage alcohol industry, the majority of that would be the ethanol industry, is out looking for – develop new markets. But again, we’ll be monitoring closely and trying to figure out ways to improve that situation.

Got it. And then last one from me. Just on the distilled inventory, you talked about selling some of the, I guess, lightly aged in the quarter. So any idea or any willingness to give us kind of what the gross add was to your business? And then also, I’m looking at a $10 million bump in accounts receivable, is that tied to a new contract?

Okay. So on the inventory, we’re going to continue to build that inventory throughout 2017 net of customer sales. And we haven’t split out the adds and the subtracts. On the customer sales, that increase – the receivables is primarily correlated to the strong revenue growth that we achieved during the quarter. And in addition, as we reported at the end of the year, we had a lower receivable balance because the December sales were lower than previous. So you had those two factors playing into the increase in the receivables balance.

Got it. That’s all from me. Thanks.

Our next question comes from Alex Fuhrman [Craig-Hallum]. Please go ahead.

Hey guys, I’m wondering if we can get a little bit of an update on how your own in-house brands have been performing. And similarly, just looking at the SG&A, what you guys have been building up presumably for some of your help with marketing and branding. Can you give us a sense of how much of that SG&A is related to your current portfolio brand and how much of that might be just building the infrastructure to support more brands in the future?

Yes, let me – I’ll take that brand part first. As I said, they’re very much in the infancy. We’ve talked before about test – our approach to – a very pragmatic approach in testing and investing. So we have two brands. And at the start of the year, they were in a couple – a few markets. So we’re going to gradually build those out into more markets. And as we learn, we’ll invest more behind them. But in terms of actually having an impact on our financials, we’re quite a ways away from them having an impact. In terms of the SG&A, I’ll let Tom talk about the numbers, but we – I think it’s important to understand that now we have six people in that group. At this time, last year, I think we had one, maybe just brought on a second one. And so we’ve brought on people through the year and finally added our – the leader for that group, Andy Mansinne, in December. And so the increases in headcount were staggered through the year. And so, right now, we’re staggering – we’re cycling around basically a six versus zero or six versus 1 number. And then as we move through the year, the last year’s number will have more of the headcount in it.

Yes, I think Gus hit on it. Now the level of spend you see throughout the year will be driven by the headcount, also the A&P spend that we’re going to implement. And in terms of how much that is, it would be a function of how quickly we roll things out. We feel very confident with the plan we have that Andy articulated at the Analyst Day. And we’re going to continue to monitor that spend and look for opportunities to continue to grow that aspect of the business.

Great, that’s really helpful, thank you.

[Operator Instructions] It appears that at this time, we have no further questions. I would now like to turn the conference – oh, pardon me. We have Will Hamilton [ph] who just joined the conference.

Just a question on the premium beverage. It’s safe that – you mentioned gins and vodkas being up. Was that pace of growth faster than what you were sort of running at last year? And because they tend to have a little bit lower margin, was that also a bit of an effect on the gross margin of distillery?

Yes, the – last year, we actually – we were – had, rather, a relatively soft first quarter on our white goods. And so we’re – we’ve talked about the migration, what we needed to do to enable our migration away from industrial alcohol, going on winning new beverage customers for our white goods. That seems to be working well for us. So our white goods business was definitely better than it was last first quarter. So that could have a little bit of mix impact. But really, DDGs was the major driver there in terms of the margin contraction.

Okay. And then just a question on the branding. I think you’ve talked about, sort of essentially, relaunching George Remus this month, correct? Can you just elaborate on some of the plans there, maybe how many more months, what kind of advertising will be supporting it?

Sure. We actually repackaged both brands. So Till vodka, which we introduced almost a year ago, as I said, you tested it before you invest. And so we have made a modification to the package to help improve its shelf impact, and that will be hitting the market in the next 45 days. We also repackaged George Remus, which we bought last fourth quarter, and we think we’ve improved the shelf impact and the premium image of that brand. And that is actually hitting the markets – the initial markets now. So over the next 45 days, you’ll see that up on shelves. Both of those are in the handful of markets in the Midwest, and we’ll be expanding to more markets over the next 60 days in the Midwest.

Okay, thank you.

Thanks Will.

This concludes our question-and-answer session. I would now like to turn the conference back over to Gus Griffin for any closing remarks.

Thank you for your interest in our company, and we look forward to talking with you again after the second quarter.