MGP Ingredients, Inc. (MGPI) Q2 2017 Earnings Report, Transcript and Summary

Good morning, and welcome to the MGP Ingredients Inc. Second Quarter 2017 Results Conference Call. All participants will be in listen-only mode. [Operator Instructions] Please note, this event is being recorded. I would now like to turn the conference over to Mike Houston. Please go ahead.

Thank you, Kate. Good morning, everyone, and thank you for joining the MGP Ingredients conference call and webcast to discuss the company's financial results for the second quarter 2017. I'm Mike Houston 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 up the call 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. This time, I would like to turn the call over to MGP's President and Chief Executive Officer, Gus Griffin. Gus?

Thank you, Mike, 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 discussion of progress against our strategy. Then we will take your questions. Now turning to results. Overall, our second quarter results reflect continued progress from the aggressive implementation of our long-term strategic plan. Results in both Distillery Products and Ingredient Solutions showed solid growth over the prior year. Total net sales for the quarter increased 6.7% over last year, driven by a 5.9% increase in our Distillery Products segment and a 10.3% gain in Ingredient Solutions. Gross profit for the quarter increased 21.2%, with both business segments showing double-digit growth. Gross margins expanded 270 basis points, reflecting strong marginal improvements in both segments. Operating income also improved 15.2%, reflecting gains in gross profit that were partially offset by increased SG&A as we increased investment in our MGP brand's initiative. Looking at each segment individually. In our Distillery Products segment, we continue to see strong demand for our premium beverage alcohol products. This demand reflects the strength of the underlying market trends and our ability to attract, retain and build strong partnerships with our customers. Our investments to expand our product offerings, capabilities and customer focus are producing results. Total food grade alcohol sales grew 7%, driven by a 15.2% increase in sales of premium beverage alcohol. We continue our efforts to migrate our business away from industrial alcohol. In this quarter, premium beverage alcohol accounted for 69% of total food grade alcohol sales. By comparison, it represented 66% for the 2016 full year. While our progress may not always be linear, we remain pleased with the pace of this migration. While the demand for our products remains strong, our margins continue to reflect pressure from -- downward pressure from softening pricing for our distillers feed co-product or DDG. Sales at Distiller's feed and related co-products declined 12.6%, with pricing reflecting the supply demand dynamic created earlier in the year by China's increased tariffs on imported DDG. Despite this headwind, gross margins expanded 210 basis points and segments gross profit grew 16.8%, reaching $16 million for the quarter. Consistent with our long-term strategy, we continue to build our inventory of aged whiskey. In addition to using this aged whiskey to support the development of our own brands, it is also used to strengthen our market position and our ability to attract and retain new distillery customers. Due to the robust growth of the American whiskey category, we continue to see strong demand for lightly-aged whiskey as customers seek to fill inventory gaps driven by higher-than-expected customer demand. In response, we continue to leverage limited sales of lightly-aged whiskey inventory to support our existing partnerships and to develop new customers for our new distillate products. Even with these sales, we continued to build our inventory of aged whiskey. Our total aged whiskey inventory, at cost, is now over $56 million. Turning to Ingredient Solutions. Consistent with our strategy of maximizing the value of our production, we saw a strong growth from a higher-margin specialty proteins and starches. Quarterly revenues grew 10.3%, while gross profit grew 53.7% to $2.9 million. Gross margins expanded 540 basis points, driven by a higher net sales of specialty wheat proteins and starches and lower input cost. While we continue to work to take full advantage of the macro-consumer trends benefiting this segment, including high-fiber, enhanced protein, non-GMO and plant-based proteins. We are particularly pleased with our progress in developing our TruTex textured protein business. This specialty protein line is well-positioned to fully benefit from the increased consumer interest in plant-based proteins. That concludes my initial remarks. Let me now turn things over to Tom Pigott for a review of the key metrics and numbers. Tom?

Thanks, Gus. As Gus discussed, this quarter featured strong revenue growth and gains in gross profit in both segments, as well as increased operating cash flow. Overall, we're pleased with the company's performance during the quarter. For the quarter, consolidated net sales increased 6.7% to $85.8 million. Gross profit increased 21.2% to $18.8 million, reflected in stronger gross profit results in both Distillery Products and Ingredient Solutions. Gross margin increased 270 basis points to 22%, also reflecting gains in both operating segments. We continue to invest for future growth in SG&A to build out our branded platform. For the quarter, SG&A expense was up $1.9 million due to an increase in professional fees, as well as advertising and promotion and personnel costs. The strong gross profit performance more than offset these investments to support our long-term growth, producing a 15.2% increase in operating income for the quarter. Our joint venture earnings from Illinois Corn Processing or ICP decreased from $1.1 million in the second quarter of 2016 to a loss of $800,000 this quarter. As previously announced on July 3rd, MGP completed the sale of this equity investment in ICP. Our tax rate was 31.6% in the current quarter, down from 36.1% in the prior year quarter. The reduction in rate was primarily due to the favorable impact of a valuation allowance release and state tax credits we received. Net income for the quarter increased 1% to $6.4 million and earnings per share were flat at $0.37 per share, as strong growth in core MGP business segments was offset by the lower operating results from ICP. As I mentioned, during the third quarter, MGP completed the sale of its equity interest in ICP. During the second quarter, and prior to the transaction closing, MGP received special distributions of cash from ICP, totaling $7.4 million. $7.1 million of the distribution was reported as operating cash flow. MGP's operating cash flow totaled $10.8 million year-to-date including $7.1 million. The remaining $300,000 was treated as a return of investment and including an investing activities on the cash flow statement. At closing, which was the third quarter event, the company received cash proceeds of $9 million before transaction fees and taxes and a $14 million promissory note for the sale of the investment. These closing transactions will be reflected in the company's third quarter results. Recognizing the company has strong cash flow from operations, a solid balance sheet and favorable access to credit markets, the board recently announced a special dividend of $0.85 per share, which was -- is funded by the ICP distributions, I mentioned, and the initial cash proceeds from the sale. Today, the board also announced the second quarter dividend in the amount of $0.04 per share. The board views dividends as an important way to share their success of the company with shareholders. Despite the headwind and DDG pricing, we mentioned, MGP is in a strong position to continue to deliver on its full year guidance. Operating income is expected to grow 10 -- between 10% and 15% annually from 2016 through 2018. This guidance excludes anticipated gain from sale of equity interest in ICP, which will be reported - recorded on the equity method investment earnings line of the income statement, and a gain from favorable litigation settlement and asset sale gain recorded in the third quarter of 2016. Recognizing the difficulty of projecting 3 years into the future, our conservative investment growth and operating income in 2019 is 15% to 20% as the sales of aged whiskey become more significant factor. Moderate growth is expected within the sales in 2017, subject to some volatility as the company continues to shift sales from industrial to premium 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. Now let me turn things back over to Gus for his concluding remarks.

Thanks, Tom. We are pleased with our second 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 growing premium beverage alcohol and migrating away from lower margin industrial alcohol. Our Ingredient Solutions segment is seeing the results of our efforts to strengthen on positioning against macro-consumer trends. We're also laying the foundation to capture greater share of the value chain with our brand's initiative. We've expanded a number of markets for both our Till American Wheat Vodka and George Remus bourbon brands. We're also expanding our brand portfolio. In recognition of the repeal of prohibition later this year, we'll be introducing a superpremium, limited edition extension of George Remus, Remus Repeal Reserve. This offering will be available on current George Remus markets. In addition, amplifying our narrow and deep philosophy to market development, we'll be introducing Tenner's Creek blended bourbon into the Indiana market, a whisky made by hoosiers for hoosiers. We continue to invest to grow, implementing key capital expenditure projects and putting away additional whiskey. Lastly, as Tom discussed, we completed the sale of the noncore ICP asset, reducing the overall volatility of our results and allowing us to focus on our core businesses. 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 superior long-term shareholder returns. That concludes our prepared remarks. Before we open the question-and-answer portion of the call, I'd like to recognize a key member of our Investor Relations team, who is retiring. Bob Burton of Lambert, Edwards & Associates, has been instrumental in helping us effectively communicate our story, and his council and support will be greatly missed. Operator, now we're ready to begin the question-and-answer portion of the call.

[Operator Instructions] The first question comes from Bill Chappell of SunTrust.

Couple of questions. At first, just on the eased inventory. Can you talk about how much maybe came off this quarter versus earlier in the year and if there are plans - from what you see in terms of signing contracts or just the actual age of the inventory because I think you've been putting it away for now, I believe three years. Do you see a greater amount coming off in the third and fourth quarter?

Well, there are long - obviously, our long term strategy is to continue to build that. You're right, we started putting it away really in '15 and then '15 and '16 really got aggressive about putting it away. We started - you started seeing some limited sales of lightly-aged inventory at the end of the - towards the end of '16. But what's really important to us is the long-term focus of continuing to build that, that both of the size, the value of the inventory and the age of that inventory to leverage down the road.

Yes, and Bill, I'll just add it - we don't want to provide specific numbers out there, because given the rapid growth in the category, customers are finding themselves with needs and sometimes it's difficult for us to predict those needs. But we do have rigorous margin criteria and in terms of an age requirement, in terms of what we will employ. We're certainly focused on driving the long-term returns.

Okay. And then on the DDG side, now, you’re midway through the year or more than midway through the year, do you have an idea of what impact that will have on the profits year-over-year versus '16? And is there any signs of that improving as we move into '18?

Yes. So year-to-date, on distillery, it's impacted the margins by 150 basis points. We do not see that improving at this point in the state - at this point in the process. Those markets continue to be pressured.

I'd say, at the same time, but we don't expect it to get worse, either. We think there's been a fundamental change in the market, in the supply and demand dynamic. So it's - we expect it to be with us, but we don't expect it to get worse either.

And there's no seasonality, so it's a flatline each quarter? Is that right?

Yes.

And then finally, just on the Ingredients Solution, this is probably the best performance in many years for Ingredient Solutions. Was there any one-time new customer wins or anything that drove that or are we on better footing?

We certainly had a strong quarter in Ingredient Solutions. And you're right, it's one of the strongest gross profit quarters in, I think, the last two years. We certainly had an easier comp. I think - but overall, we are seeing - a combination of factors helping Ingredient Solutions. One, we have been able to maintain pricing, despite lower input costs, which has helped the margins. And two, we're seeing volume growth. As Gus mentioned in his comments, the textured wheat protein business is doing well and we're well-positioned for continued growth there. So overall, we are feeling very good about Ingredient Solutions.

So not any like one big customer like there was, I guess year, a year or two years ago?

No. We've all those consumer macro trends, increased fiber-enhanced protein, non-GMO, plant-based proteins. And we've been working very hard over the last two years to better position our portfolio against such trends, and we're starting to see those results. TruTex with the plant-based proteins would be a particular call out. But I think, as Tom said, we were going against an easy comp, so the increase in gross profit might be a little bit inflated. But the overall strength of the performance was - is one we haven't seen in quite a few quarters. And so I think we're starting to get good traction on all the efforts that we've done over the last two years. Yes, and I don't think you'll see a hockey stick, but I think we're starting to the results of those efforts and starting to see that traction.

The next question is from Alex Fuhrman of Craig-Hallum.

I wanted to ask a little bit about some of the new brands that you're going to be launching. Looks like we've seen SG&A expenses ramp up the last couple of quarters, presumably, a good chunk of that is related to your branded effort. Do you feel that the team that you have on the branded side is where you need it to be to support these launches coming forward? Or should we expect to see, perhaps, a little bit more investment. And then, thinking about just the launch of an aged bourbon brand, do you have sufficient quantities of whiskey aged beyond just what you've been putting away since 2015 to be able to hit the market quickly with a brand like that? Or do you need a few years to let your own inventory age into a launch like that?

Yes. We can get to the SG&A piece first. I think it's important to remember that we're really starting from ground zero. So when we talk about our MGP brand's initiative, when I got here in 2014, we had 0 people working on it. Last year, the first half of 2016, I think we had two people and now we have six people. So it's been a significant ramp up, the number of people. I don't think we need more people to expand our portfolio, but as we expand our geographic markets, we'll have to add to support that. So I think what we're doing is we're starting to cycle around versus those hires that most of those people came on in the second half of 2016, so the increase, we're starting to cycle around those initial increases. In terms of whiskey, we even - when we bought the distillery, there was some there, and we've been very judicious about what we've hung on. So obviously, this Remus Repeal Reserve we're coming out with is going to have some old whiskey in it. And so we have the whiskey to come out with products like that. And as we've said before, the last thing we want to do is short our own brands. And so we are making sure that we hang on to the whiskey we have and are putting away the right amount of whiskey to support all of our brands initiative, whatever they may be.

That's really helpful, Gus. And then just thinking about a lot of your customers that have been growing nicely themselves for the last couple of years. Some of them are seeing accelerating growth even the last few years. To the extent that you're getting interest in having conversations with customers about selling lightly-aged whiskey. Just trying to get a sense of the pricing that will be seen in the market for whiskey that is 12, 18 months old, not necessarily fully-aged bourbon, but would be curious to the extent that you can comment on the supply and demand dynamics for the more lightly-aged bourbon.

Yes. Alex, there continues to be a very strong demand for it, not a very transparent and visible market for it. But we are seeing - there's nothing to diminish our view, outlook of what that whiskey will be worth. And we're seeing, for the lighter-aged whiskey, we are seeing things in line proportionately with that longer-term view.

The next question comes from Francesco Pellegrino with Sidoti.

So, congrats on the divestiture of ICP. I know that adds a little bit more transparency into the business. I just wanted to talk about the contracts with this business now going forward. Now that ICP is on your balance sheet or isn't on your books anymore. Can you still purchase contracts? Can you still purchase volumes via contracts or are you now subject to like spot markets rates?

We expect to continue to conduct business with ICP. They serve a couple of roles for us. One, they helped fill gaps in our supply of industry alcohol for customers as well as they provide some raw materials that help us in the beverage alcohol market. So we continue to expect to conduct business with them. We've done it on a purchase order basis over time and we don't see any real change in that at this time.

You can get a little bit of leverage from this relationship since you represent, historically, such a significant part of ICP's business now? And just in regards it's already getting a little bit less volatility in regards to cost on your end now going forward?

I think the reduction of volatility would just simply be from the lack of volatility going forward in the equity pickup line from the ICP earnings. But in terms of our actual purchases from them, whether they'd be product - then we turn around and sell it to another customer or product that we use as a feedstock. That was a arms length transaction in the past. So I wouldn't think there will be much change there.

Yes, we feel like the pricing that we received previously was competitive and we think it'll be the same going forward.

Okay. Just to put it into perspective. I know you touched upon it briefly, some of the pressures that the premium beverage alcohol product - products are facing. When we put it into context with the sharp deceleration in barrel put away, how should we be viewing that relationship between the two, Gus? As your barrel put away decelerates significantly, is it lets confidence in where the market is going to be towards two or three years from now or is it just adjusting significantly with the short-term dynamics?

Yes. Let me be very clear. We have - there's certainly no wrestling in our confidence, in our bullish outlook for the - both the distilled spirits industry, and obviously, American whiskey industry or the bourbon category. And so any fluctuation our quarter-to-quarter put away has no reflection of our long-term view. It's simply a matter of what we're feeling for customers and what we can fill for ourselves at that time. So we look at it a more on a year-to-year basis and we want to make sure to we're continuing to aggressively grow that and we don't get too concerned about quarter-to-quarter fluctuations and the amount of inventory we put away. Because we believe the long-term potential is very, very strong. The underlying fundamentals of the market are very strong. If you look at the growth over the last five years, or whether you look at the growth of the last 12 weeks or the last four weeks, everything is pointing in the right direction.

And the other, Francesco, the other thing we announced is the actual warehouse it’s coming online, we're $23 million into the $29 million approved projects. And so there are number of factors that come into play each quarters in terms of what we put away, but you can expect us to continue to increase that balance as the year progresses.

One of the things that's really interesting about your long-term outlook for the category is this export market. However, we have been seeing some recent articles coming out about some of the larger ethanol producers starting to enter the beverage and industrial production category. Is there any type of competitive advantage that MGPI has as compared to the competitors now, entering the space to digest, maybe, some of the aged barrel distiller that you're already sitting on?

Yes. I think, sure you have to sort of split between white goods, Grain Neutral Spirits and bourbon. Because some of the large companies, they do flex in and out, try to flex in and out on beverage. And that's why we haven't - still we migrated away from industrial alcohol, which is more transactional. A lot of those ethanol companies try to treat it like a transactional business where we try to build strong partnerships with our customers, whether that be on the brown side or the white side. In terms of the brown side, we think we have a very strong and defensible position in the market, both due to our current position, our scale, our capabilities, our capacities, and our commitment long-term devoting partnerships and growing with people, as you've mentioned being whatever just aged whiskey and we already have a very, very broad and diversified customer base. So we think we have a very strong position in the whiskey arena and then on the Grain Neutral Sprits, we're doing that. I think that it's a fair question that people can flex in there and what's doing it for us there is our ability to build long-term partnerships with people.

Okay. I just want also switch over the Ingredient Solutions segment for a bit. It's been - maybe a segment I've been a little bit critical in the past just because margins have been all over the place. But over the past, I'm just looking at it right now, the past two quarters, we've had some pretty nice margins closer to 20%. Is there any seasonality in the fourth quarter that causes margins to be so low? And going forward, is this now a business. I know you referred to it before as, we're not going to see like a hockey stick type of margin expansion continue the way that it has recently. But can this - is this 20% business right now sustainable going forward?

Yes. I think there's two pieces to take away, there's one, don't get over excited about the percentage increase in gross profit for this particular quarter because it was going against a relatively soft comp. But we should take heart in the actual gross profit for the quarter, which was particularly strong. And before we had said we expected the segment to go along a historical low growth rates. Well we've been doing a lot of work over the last two years. And as I said earlier, we're starting to see traction. How that's going to materialize, I don't want to get too overly enthusiastic about it, but in terms of the rate and when those increases will happen, but we are very enthusiastic about the long-term potential for this business segment. And we starting to see it on numerous things, numerous different products across specialty wheats and proteins, which obviously, is where the margin is and TruTex would just be one pretty good example of us starting to see traction of a lot of effort we put in to develop that business and everywhere you look, you see our article is about consumers increased interest in plant-based protein and that's a prime example of us doing the work ahead of time to position ourselves to benefit from that long-term trend.

And to answer your question of seasonality, yes. There have been lower gross margin performance in the fourth quarter, historically, but there's no specific seasonality we can point to in that business. It's just the timing of customer orders and mix of products that flow through. And we share your enthusiasm for the progress that business has made over the recent couple of quarters.

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

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