MGP Ingredients, Inc. (MGPI) Q3 2018 Earnings Report, Transcript and Summary

Good morning, and welcome to the MGP Ingredients, Inc. Third Quarter Results Conference Call and Webcast. [Operator Instructions] Please note this event is being recorded. I would now like to turn the conference over to Mr. Mike Houston, Investor Relations. Please go ahead.

Thank you, Debbie. Good morning, everyone, and thank you for joining the MGP Ingredients conference call and webcast to discuss the company's financial results for the third quarter 2018. I am Mike Houston with Lambert IR, MGP's Investor Relations firm. And joining me today 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'll 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, Mike, and thank you all for joining us. On this call, we will provide an overview of our results for the quarter, updates on key financial performance metrics and a discussion of progress against our strategy. Then we'll take your questions. Now turning to the results. Our third quarter results exhibit the top line improvement we expected, with consolidated net sales for the quarter up about 10% and operating income increasing by almost 15%. While we remain very pleased with our progress against all parts of our strategic plan, we did experience some short-term production challenges at our Lawrenceburg facility that impacted our margins. We are confident that the issues have been resolved and we are poised for further growth in the fourth quarter. Based on the improved momentum of our business and the continued solid execution of our strategic plan, we are again reaffirming our operating income growth guidance for the year. Looking at each segment individually. In our Distillery Products segment, net sales finished the quarter up 8.3%, while gross profit decreased 1.4%. Net sales of food grade alcohol increased 6.8% from the prior year period, with both premium beverage alcohol and industrial alcohol up for the quarter. We remain focused on the long-term opportunities provided by our unique positioning within the distilled spirits industry. We continue to experience strong demand for our bourbon and rye whiskeys, and our new distillate business grew nicely this quarter. We've been very successful in attracting new customers, and the additional inventory we put away last quarter supported the increased sales to both new and existing customers this quarter. We believe our plan for sustainable growth in premium beverage alcohol remains on track. Also of note, sales of dried distillers grains, or DDG, had a positive impact on our Distillery Products segment results in the third quarter, growing 21.4%, primarily due to improved pricing. While we have seen slightly improved pricing versus prior year quarter, in each quarter this year, we maintain our view that these results are not a sustainable trend due to the unchanged macro environment that led to lower pricing beginning in the first quarter of 2017. Despite the strong top line results in our Distillery Products segment, we experienced short-term production challenges at our Lawrenceburg facility this quarter. As part of our continued investment in this facility, we updated our systems control technology this quarter. As sometimes happens, the installation did not go quite as smoothly as planned, and there were delays in the facility returning to its full operational capabilities. The issues have been resolved, but this delay not only negatively impacted segment gross profits for the quarter but also affected our ability to put away additional barrels. Gross margin for the Distillery Products segment declined by 200 basis points from the prior year period, primarily due to this higher production cost at our Lawrenceburg facility as well as lower gross margins and profits on industrial alcohol. The outlook on industrial alcohol remains negative. The market continues to be oversupplied and very price competitive. Our industrial alcohol business is very challenging, and as a result, we anticipate additional margin pressure on the Distillery Products segment. Now turning to our barreled whiskey inventory. After significantly increasing inventories last quarter, our investment in barreled whiskey inventory declined slightly this quarter, and now stands at $71.5 million at cost. As I have mentioned last quarter, we anticipated using some of that second quarter increase to support higher anticipated sales in the back half of the year. The short-term production issues mentioned previously also inhibited our ability to grow that inventory level this quarter. Our strategy continues to be to build our inventory of barreled whiskey and to leverage this inventory to attract and retain customers for our new distillate products and to support the growth of our own brands. We believe this library of mash bills and ages will enable us to provide structure to a very unstructured market for aged whiskey. Discussions are ongoing with existing and prospective customers about the potential of these product offerings. Turning to Ingredient Solutions. Net sales grew 19.3%, marking the eighth consecutive quarter of revenue growth for this business segment. Gross profit increased by 56.8% to $3.3 million for the quarter, while gross margins increased 480 basis points due to higher gross profits on specialty wheat proteins and starches and commodity wheat proteins. Our base wheat protein can either be sold as commodity wheat proteins or further valued up to be sold as specialty wheat proteins. While we continue to see strong demand for our specialty wheat proteins and are pleased with the new customer interest in our TruTex offerings, we are also seeing strong demand for commodity wheat proteins as a result of clean-label initiatives by our customers. We are pleased with this segment's continued strong sales growth and are focused on leveraging the consumer trends of high-fiber, high-protein, non-GMO, plant-based proteins and clean-label ingredients, are consistently fueling this growth. We continue to strongly believe in the potential of these trends provide. This 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. For the quarter, consolidated net sales increased 10.1% to $95 million, reflecting growth in both the Distillery Products and Ingredient Solutions segments. Gross profit increased 5.2% to $19.6 million as a result of gross profit growth in the Ingredient Solutions segment, partially offset by a decline in the Distillery Products segment. Gross margin declined 100 basis points versus the prior year to 20.6% of net sales. Corporate selling, general and administrative expenses for the quarter were $7.6 million and decreased 7% versus the prior year quarter. Lower personnel costs and a decrease in professional fees were partially offset by investments to support our brands platform. We are focused on effectively managing these costs while still investing to grow. Operating income for the third quarter increased to $12 million compared to $7.5 million during the prior year quarter. The 14.7% increase was due to increased gross profit results during the quarter as well as the reduction in SG&A. Our corporate effective tax rate for the quarter was 22.9% compared to 34.6% in the prior year quarter, reflecting the favorable impact of the Tax Cut and Jobs Act. We are now revising down our full year tax rate guidance to 24% based on our latest forecast. Net income for the third quarter decreased to $9 million from $14.1 million and earnings per share decreased to $0.52 per share from $0.82 per share in the prior year quarter. These declines from prior year results were primarily due to the gain on sale of equity method investment recorded in the third quarter of 2017 from the successful sale of Illinois Corn Processing, partially offset by the decrease in the effective tax rate and an increase in operating income. MGP's balance sheet remains strong allowing us to continue to invest in our growth and drive long-term shareholder value. We've great access to capital to fund additional growth opportunities, such as our warehouse expansion efforts, increases in our barreled whiskey inventory or possible M&A targets that are consistent with our long-term strategy. As of September 30, 2018, $126 million remained available under the $150 million revolving credit line. Recently, the board authorized the third quarter in the amount of $0.08 per share. The board continues to view dividends as an important way to share the success of the company with shareholders. MGP is offering the following guidance for fiscal 2018 and beyond: operating income is expected to grow between 10% and 15% for fiscal year 2018; the company's conservative estimate of growth in operating income in 2019 is 15% to 20% as sales of aged whiskey becomes a more significant factor; 2018 net sales growth is projected in the high single-digit range versus 2017, subject to some volatility as the company continues to shift sales from industrial to premium beverage alcohol; 2018 gross margins are expected to continue to be consistent with 2017; the 2018 effective tax rate is forecasted to be 24% and shares outstanding are expected to be approximately 16.9 million at year-end. Now let me turn things back over to Gus for concluding remarks.

Thanks, Tom. Now I'd like to touch on some additional initiatives that support our long-term strategic plan. We continue to invest to grow in our Distillery Products segment. As Tom mentioned, our strong balance sheet and cash flow generation capabilities enable us to capitalize on key growth opportunities as they present themselves. We believe in the long-term growth potential of the American whiskey category, and we continue to make significant additional capital investments in our barrel warehouse program. Our anticipated investment of approximately $51.8 million continues on track to be completed in 2020. We expect this increased investment will enable us to meet the long-term storage needs of both our new distillate customers and our own aging whiskey inventory. As of September 30, 2018, we had incurred approximately $33 million of this total investment. As I've mentioned in previous calls, our core focus in the Distillery Products segment will always be supplying other brand owners with premium distilled spirits. We are realizing the benefits of our efforts to become the supplier of choice for all brand owners. Net sales of premium beverage alcohol this quarter were the highest since the implementation of the company's strategic plan. We also continue to implement initiatives to strengthen our positioning in the craft segment. We continue to be pleased with the positive momentum we are experiencing in our own brands initiative. Our brands continue to garner top accolades for their high quality, including a double gold medal at the Washington Cup Spirits challenge for George Remus Straight Bourbon Whiskey; a double gold at the San Diego's Spirits Festival for Rossville Union Master Crafted Straight Rye Whiskey; and the Tasting Table magazine awarding an impressive 98 points for the next limited release of our Remus Repeal Reserve Straight Bourbon Whiskey. Series 2 of this offering will be released on November 13. The strong ratings and the awards our brands have received this year and the consumer demand for them further validates our position as the trusted source for the highest-quality premium spirits. As I've mentioned in the call last quarter, our continued focus throughout the balance of the year will be on increasing distribution and sales velocity in our existing markets. As demonstrated by these accomplishments and the results this quarter, we are well positioned in the market and remain focused on our key strategies over the long term. We remain confident that the continued focus and commitment to these strategies will yield superior long-term shareholder returns. That concludes our prepared remarks. Operator, we are now ready to begin the question-and-answer portion of the call.

[Operator Instructions] The first question comes from Bill Chappell with SunTrust. Please go ahead.

Thanks, good morning. Gus, just talking about the -- on each side, do you still expect high single-digit growth for the full year? And if so, that implies a pretty big ramp in the fourth quarter. Just trying to understand, is the company capable or does it have the capacity to hit that when orders are so truncated towards the fourth quarter?

Yes, and I think the upper -- the high single digit was total company revenue. I don't believe we've provided one for premium beverage. But yes, we feel we have both the capacity and the capability. I think just talking about premium beverage alcohol and, specifically, the whiskey, I think, we've several things going for us there, Bill, is -- one, the category continues to be very strong, whether it's both the premiumization and the overall growth in the American whiskey category, continues to be very strong. We continue to add customers. You've heard us speak repeatedly about our efforts to go out and recruit new customers to be the supplier of choice to all premium beverage suppliers. And so that's going very, very well. We're adding customers. We don't disclose the actual number of customers, but we are adding them at a faster clip than we did last year, which was a faster clip than we did the year before. So the initiatives that we are implementing there have really paid dividends. And so we're very pleased with that. We're also seeing that we're backing right horses. Our customers, their brands are winning awards. They're showing impressive growth rates. So there, our marketing efforts are going very, very well. So on a longer-term sense that all looks very good. Now just looking at the next 60 days, we have done very detailed forecasting on the customers, very disciplined approach to this. They've been reviewed by management, and that's why we have the confidence that we'll be able to do whatever those numbers.

Okay. And in terms, just sticking on that, of what impact the production delays had on sales in the quarter. Is there anyway to -- I know you said you weren't able to put away as much inventory, but how about in terms of what the actual sales that was there any delay from that standpoint?

No, this is Tom, Bill. So from a top line standpoint, we were able to utilize existing inventory to fulfill all sales. So there was no sales impact. But as you kind of related to that, we weren't able to increase that inventory balance as much as we would've liked.

Okay. And then -- go ahead.

Just a build on that. As we said last quarter, we were putting away -- we thought we would pool down some of that inventory that with the -- sort of the big increase we had in the second quarter over the back half. So we had the firepower. Certainly, it hurt our gross profit and, certainly, it inhibited our ability to put away more barrels and further grow that inventory during this quarter. But we have the capacity and we had inventory to -- as we anticipated.

Thanks. And then just on the aged, obviously, the class of '15 inventories coming due next year. Can you give us some update? I've got to think you're further down the path of conversations with larger players with how you're going to place this. And then just any change to your outlook on kind of what the value of that aged inventory is versus unaged.

Yes, as we've said the last, I think, two quarters, we continue to have those discussions. Our prospective partners, the people who are going to use this are putting their plans in place that when they will need it. We don't have anything more concrete that we're ready to share with you now. I will caution you, remember, all the 2015 inventory doesn't turn four years old on January 1, so it will be spread out through the year. But we're feeling increasingly confident in both the demand for that inventory and the pricing for that inventory. So to your second question, we haven't seen anything that would change our view of the value of that inventory.

The next question comes from Alex Fuhrman with Craig-Hallum Capital Group. Please go ahead.

Great. Thanks guys for taking my questions and congratulations on a really nice quarter. I wanted to ask about the Ingredient Solutions side of the business, it looks like the business has been really consistently growing for the past couple of years and even accelerating over the last quarter. I'm just wondering how sustainable that trend is, if you see growth there continuing to be very strong over the next couple of years. And then, Gus, I think in the prepared remarks, you mentioned that the commodity side of the business, including Ingredients, is starting to pick up as well as companies move more towards clean label. Can you just give us a sense, I think, we're much more familiar with the health attributes of some of your specialty products, but in terms of the commodity portfolio, I mean, how are you marketing this? Is it fair to assume those products are all non-GMO? Are there other clean-label attributes that people are really gravitating towards your commodity portfolio as well?

Yes. So let's -- I'll take the -- sort of an order. We see this as a sustainable long-term trend, the growth of this business segment, really, because of those consumer trends, so the high-protein, high-fiber, non-GMO, plant-based proteins and the clean-label products. So anyways, the consumer interest in those trends, we see that going on. All of our products are made from wheat. And so they are all verified non-GMO. So even -- whether they'd be specialty or commodity, they are all verified non-GMO. The clean label is probably the new-news there. And certainly, across the food category, people are trying to clean up their labels, consumers want simpler labels, they want cleaner products. And so the demand for that -- and we've introduced some new products, some different ways we've treated our commodity proteins, commodity proteins sort of is a basket of different offerings we have. So we've introduced some new products there to better address that desire from our customers. And that's turned out to be a stronger demand and better pricing than it has been in the past because of the -- basically because of that demand.

Great. That's really helpful. Then I'll take a follow-up on the beverage side of the business. The small decline in the aged distilled spirits, just trying to get a better sense of where that came from. Obviously, it sounds like some of that was due to the production issues, but was -- I'm just trying to interpret your comments in the prepared remarks, it sounds like a lot of that, that you sold, was some of the $5 million of products you put away in the second quarter. So just want to make sure I understand that correctly and is it fair to assume that the big majority of the aged product that you sold in the third quarter was just probably 3, 4, 5 months old, things that you distilled in the second quarter?

Yes, as we foreshadowed last quarter, we said, look, we really ramped up our inventory in the second quarter because we had the available capacity and we knew our new distillate sales were going to be strong in the back half. And so that's exactly what happened is, we put that away in the second quarter anticipating needing it for the third and fourth quarter. So that was certainly one thing that kept that inventory from growing further because, as we anticipated, we're going to need it. And then the second thing is the production issues in Lawrenceburg kept us from really putting away being able to offset that. And we do think those issues are solved. So we're back to running well. That's not an issue anymore, and consistent with our strategy, we anticipate continuing to build that inventory.

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

Thank you for interest in our company and for joining us today for our third quarter's call. We are certainly pleased with our progress and the sustained strength of the categories in which we compete, and we look forward to talking with you again after the fourth quarter.

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.