MGP Ingredients, Inc. (MGPI) Q2 2019 Earnings Report, Transcript and Summary

Good day. And welcome to the MGP Ingredients Incorporated Second Quarter 2019 Results Conference Call and Webcast. [Operator Instructions] Please note this event is being recorded. I would now like to turn the conference over to Mike Houston, Investor Relations. Please go ahead, sir.

Thank you, Nancy. 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 2019. I'm Mike Houston with Lambert and Company, MGP's Investor Relations firm and joining me here members of their management team, including Gus Griffin, President and Chief Executive Officer, and Brandon Gall, Vice President of Finance and Chief Financial Officer. We will begin the call with management's prepared remarks, and then open 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. At this time, I'd 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 I will turn to the results for the second quarter. We saw improved results across most parts of our business this quarter, including the expected solid rebound in sales of New Distillate, stronger sales and margins for a white beverage and industrial alcohol products and gains in both revenue and gross profit for Ingredient Solutions segment. Both of our business segments showed topline growth over the prior year and as a result, our consolidated sales for the quarter increased more than 2%.Even with these improvements, our operating income declined over 2% as sales of aged whiskey lagged our expectations. Despite the slow start to the year for sales of aged whiskey, we remain confident in both the long term demand for in the value of this inventory and expect to see a significant increase in sales of aged whiskey over the remainder of the year. However, we believe there is some possibility we might have difficulty completing transactions for all of our projected sales of aged whiskey by the close of the year.As a result, we are revising our guidance for the full-year to include that possibility. Looking at each segment individually. Our distillery products segment sales finished the quarter up 1.9% to $74 million while gross profit declined slightly to $16.5 million or 22.3% of segment sales. As expected, we saw strong double-digit growth in sales of new distillate this quarter and as a result, year-to-date sales of new distillate are up low single-digits. This quarter was our third largest quarter ever for new distillate sales and reflects both the continued robust health of the American whiskey category and our strong position supporting that growth. This growth was broad-based and reflects a rebound in sales to our multinational and national customers, as pricing in demand for new distillate remains strong. Our investment in expanding our sales force also continues to pay off, as once again we added more incremental new customers during this quarter than the prior year period. Sales of aged whiskey were down for the quarter and continue to trail last year.Despite soft aged sales during the first half of the year, our trailing 12 months revenue for total brown goods is up 8.2% over the prior year period, reflecting sustained growth rates above those of the American whiskey category. While sales of aged whiskey are below our expectations, year-to-date, we expect to see a significant increase in sales over the remainder of the year. Several orders failed to transact at the end of the quarter, highlighting both the longer term demand in the inherent challenges in implementing this strategy. As we progress through the implementation of the strategy, we are beginning to better understand the timing of demand and obstacles to transacting customers orders. Although, the demand is solid and we have consistently achieved pricing at or above our target, some of our customers struggle with access to credit or financing, which poses a challenge to transacting the sale on a timely basis. Others have had to prioritize the use of available funds, putting up purchases of aged whiskey until the need is absolutely critical. Finally,we believe that some customers may be beginning to try to use the public reporting of our quarterly results and progress against the specific strategy as a bargaining tool. As I've indicated in prior calls, we were not for sales of our aged whiskey into certain quarters. While we will continue to aggressively stall aged whiskey, our strategy to deploy this inventory will be executed in a way that maximizes its long-term economic value. As a reminder, we believe the price of our remaining whiskey inventory will continue to increase as ages and subsequent years, increasing its value and expanding the range of solutions we will be able to offer customers. We continue to see a diverse group of customers for our aged whiskey and our visibility to when those sales will be finalized improves throughout the year. We're off to a good start to the back half of the year having already recorded actual sales or received purchase orders for about 12% of our projected sales of aged whiskey for the remainder of the year. Additionally, we are in active ongoing discussions with specific customers for another approximately 60% of those projected sales. This visibility coupled with the continued solid trends of the category gives us confidence for strong aged sales growth in the back half of the year. As we provide structure to this unstructured market, it is becoming increasingly clear that MGP has a unique competitive advantage. Our extensive library of aged whiskey along with an expanded sales team and our ability to support the brands growth, regardless of its size, offers a position of strength as we sell more aged whiskey in the future. Sales of premium beverage white goods increased 1.6% for the quarter with slightly improved pricing in margins, similar to premium beverage white goods sales of industrial alcohol also increased for the quarter, up 6.9% with slightly improved margins. While the margin compression moderated this quarter, both of these markets continue to be hypercompetitive in the chronic oversupply dynamic in the industrial market still exist, we expect the situation to continue for the foreseeable future. Sales of dried distillers grains or DDG declined over 7% reflecting short-term micro factors. Our outlook for DDG pricing continues to be based on the unchanged macro environment that led to lower pricing in the first quarter of 2017. Revenue from warehouse services increased over 19%, reflecting in part growth in a number of customer barrels aging in our whiskey warehouses in other services we provide. Looking forward, we expect our brown goods business to deliver improved performance over the remainder of the year, as a result of capturing delayed sales of aged whiskey from the second quarter as well as continued strong demand and pricing. Turning to ingredients solutions, sales grew 5.6% to $16.5 million, while gross profit increased to $3 million or 18.3% of segment sales. We were pleased with the improved pricing and mix across the segment particularly as we continue to cycle with the loss of a large customer for our TruTex textured wheat protein product at the end of last year. We feel very good about the robust project pipeline for this product and remain confident it will be a driver of long-term growth. We are also continuing to see increased customer interest in our Fibersym and FiberRite products following their approval as sources of dietary fiber by the FDA. These products are ideally suited to help companies develop healthier food offerings, delivering high fiber content while lowering carbs. We're seeing a similar trend in Asia with consumers increasing interest in a healthy diet with lower carbs. Fibersym is benefiting from this trend and is well positioned for long-term growth. Sales of our commodity wheat proteins and starches increased from the prior year period as more customers seek to expand their clean label initiatives which have enhanced our margins in those areas of the business. Overall both of our business segments continue to benefit from favorable consumer trends and we remain confident in our long-term strategy. We continue to see strong demand and pricing for our products while we have adjusted our outlook to reflect the possibility that we might have difficulty completing transactions for all of our projected sales of aged whiskey by the close of the year. We remain very confident and encouraged about the long-term outlook. This concludes my initial remarks. Let me now turn things over to Brandon Gall for review of the key metrics and numbers. Brandon?

Thanks Gus. For the quarter consolidated sales increased 2.5% to $90.5 million reflecting growth in both the Distillery Products and Ingredient Solutions segment. Consolidated gross profit increased 0.4% to $19.5 million as a result of gross profit growth in the Ingredient Solutions segment partially offset by decline in the Distillery Products segment. Consolidated gross margin decreased approximately 40 basis points to 21.6% of sales down from 22% in the prior year quarter. Corporate selling, general and administrative expenses for the quarter were $8.6 million up 4.1% versus prior year due to higher professional fees and personal investment to support our brand's platform. We're focused on effectively managing these costs while still investing to grow. Consolidated operating income decreased 2.3% to $10.9 million compared to $11.1 million during the prior year quarter reflecting the increased SG&A expenses and year-over-year decline in Distillery Products segment gross profit. Our corporate effective tax rate was 25% in the current quarter compared to an effective tax rate of 30.6% in the prior year quarter. This decrease was primarily due to the 2018 change in estimate related to the sale of the company's equity method investment that did not recur in 2019. With an updated view on the 2019 state and federal tax legislation we are reducing our projected effective tax rate for 2019 to approximately 19%. Net income for the second quarter increased 5.1% to $7.9 million and earnings per share increased $0.02 per share to $0.46. These increases from year prior results were primarily due to lower income tax expense resulting from a decrease in the effective tax rate partially offset by lower operating income. We discussed the strong fundamental cash generating capability of our business which allows us to provide positive operating cash flows even as we invest in our inventory of aging whiskey. In the second quarter, cash provided by operations was $6.9 million one driver of cash provided by operations was the reduction in accounts receivable of $2.3 million during the quarter reducing our ratio of day sales outstanding. While we expect continued normalization of day sales outstanding, these metrics remained slightly above historical levels due to higher sales, timing of sales as well as product and customer mix. During the period, we also invested a net $6 million for growing our barrel inventory for aging as we continue to see long-term value in building this inventory. MGP's balance sheet remains strong allowing us to continue investing in our growth and drive long-term shareholder value. We continue to have very good access to capital. As of June 30, 2019, $148 million remained available under the $150 million revolving credit line. Our capital allocation strategy remains consistent with prior quarters and years as we continue to build aged whiskey inventory, expand our warehouse capabilities, and contemplate possible M&A opportunities that are consistent to our long-term strategy. Recently the Board authorized a second quarter dividend in the amount of $0.10 per share. The Board continues to be dividend as an important way to share the success of the company with shareholders. MGP is providing the following revised guidance for fiscal 2019. 2019 sales growth is projected in the mid-single-digit percentage range versus 2018. 2019 gross margins are expected to increase modestly as compared to 2018. The company's estimate of growth in operating income in 2019 is 10% to 20%. 2019 effective tax rate is forecasted to be approximately 19% and shares outstanding are expected to be approximately 17 million at year-end. Earnings per share are forecasted to be in the 255 to 275 range inclusive of our new lower projected effective tax rate. Let me now turn things back over to Gus for concluding remarks.

Thanks Brandon. Now I’d like to touch on some additional initiatives that support our long-term strategic plan. The American whiskey category continues to be strong and we are very pleased with our unique position supporting that growth. Our warehouse expansion plan remained on track during the quarter allowing us to increase our storage capacity and complete the project by the end of 2020. As Brandon mentioned, we also invested an additional $6 million in our aging whiskey inventory. This brings our inventory of aging whiskey to $85.5 million at cost. While we will be selling aged whiskey from this extensive library of inventory, we plan to grow the value of this inventory at cost through 2019. We remain confident in both the demand and pricing for our aged whiskey and our plan for deploying this inventory and maximizing its economic value over the long-term. We continue to progress our brands initiative focusing on increasing distribution and sales velocity in our existing markets. In November, 2019 we will release Remus Volstead Reserve, Straight Bourbon Whiskey a one-time extremely limited 14-year-old bottled-in-bond offering. The new release which has a suggested retail price of 199.99 for 750 milliliter bottle coincides with the hundred anniversary of the start of National Prohibition. This one-of-a-kind whiskey, highlights all of our exceptional whisking making capabilities. We're also proud to continue our efforts to help local farmers affected by the devastating Midwest flooding. Working with the nonprofit farm rescue, we shipped over 400 tons of dried distillers’ grain, from our Atchison facility to local farmers to help feed their cattle. Helping those in need in our local and regional communities is an important part of the MGP culture. These DDG shipments honored this commitment while helping the farming communities to make our business possible. While we're still not where we would like to be in terms of year-to-date operating income growth, I would like to reiterate our continued confidence that focusing on our key strategies will drive superior long-term shareholder value. Both of our business segments continue to be well positioned against strong macro consumer trends and we continue to believe that despite quarterly volatility. The aggressive implementation of our strategic plan will drive strong growth in 2019 and beyond. Operator, we are now ready to begin the question-and-answer portion of the call.

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

Let’s just dive straight into aged - something clearly has happened from last quarter to this quarter in terms of. You were very confident that the aged sales would enable you to get to the guidance to now you're adding a lower end into the guidance .And clearly the stock today tells your people don't believe that you can actually sell the product. So I'm just trying to understand here best case scenario you - the company has been surprised by how complex this process is in terms of placing the barrels and it eventually will happen, worst case scenario, customers are now pushing back and saying, no we’re not going to pay three times. So is there any way to give us comfort in the near-term that you're selling anything at three times or that it's more to the former versus the latter?

Yes, great question and obviously the crux of the matter. So first of all we’re selling less age this year, so far we plan to some more aged than last year. We are selling less volumetric but we’re selling older whiskey and we are consistently hitting our target which is 3X. We’re consistently achieving to that or above that. So we - while people may be pushing back as a negotiating employee, we’re not selling it to them a bold react. So we think it is a - we think any pricing pressure is temporary as a negotiating employee and as I said in my comments I think people are - we've said, we have an extensive library of inventory which may have actually worked against us because people now know what they were trying to - what we’re trying to do, so they're using some of our - we brief some of our customers, will try to use as a negotiating employee. As we’ve clearly said, our goal and our plan is to maximizing the economic value of that whiskey, of that asset and so we're not going to either try to push it into any quarter, and consistent with that approach we rise that there's a possibility that we might not execute all the plan sales. Again our plan sales would put us write in guidance but there may be some possibility we might not execute all those plans sales by the end of the year and that's what we highlighted the possibility and extended the bottom of the guidance.

And so going back to kind of comfort as you move into 3Q, did some of the sales show up, are they - what can give us comfort that they will happen even at that level and also you said, your plan sales would get you right in the middle of guidance, by my math,if you had sold a fair amount of the class 2015 inventory you could exceed guidance…

So let me clarify. Let me clarify. Thanks for digging into more. It would put us a the top of our guidance. Our projected sales would put us at the top of our guidance. Again, we’re really the - as I’ve highlighted over the last couple of calls there is, we've other headwinds industrial ingredients and where we’re highlighting the possibility of not being able to transact all those sales this year is the incremental sales required to overcome the shortfall in industrial ingredients this year. So we were more confident in our ability to lean in and execute the required incremental sales to overcome those shortfalls by the end of the year. And now were highlighting that there's a possibility we might not be able to lean in and get those incremental sales certainly without - so the impossibility is we’re not going to diminish the economic value of it, so wanted to highlight that. But if we stall all of our projected sales we will be at the high end of our guidance.

And digging a little bit on each side, if I look at the growth is there a way to parcel, how much of this was just push from last quarter to this quarter versus how much is going to leave growth and when I say that, just trying to understand what pricing trends for un-aged look like if there's been any pressure there?

No, our pricing on but we're - where we believe in the overall demand in the market and the strength of our position in the market, so our pricing for new distillate and our pricing for aged have - our view of that have remained unchanged, so we are getting the pricing we want for both products and obviously on aged it's wagging our - the volumetric is wagging our expectations. But on the new distillate, we’ve highlighted in the first quarter call that we had some timing issues. First, there are new distillate sales. In the first quarter were soft and we highlighted the timing issues with the multinational, national customers that came back as expected because it was a timing issue and we continue to recruit new customer, so across all the segments and so our recruitment of new customers is also driving that business. So we view our all aspects of our new distillate business as being healthy.

So just on that - the DSO number remained elevated, I would've expected that to come down as the orders came in, can you give me some clarity there?

Thanks, Bill. I’ll mentioned this a little bit in the opening remarks but happy to discuss it further. So we did acknowledge a temporary spike in AR on the call in the first quarter. Since the end of the first quarter, our accounts receivable balance has decline more than 6% in total. Our sales rose more than 1% for the first quarter. So resulting in a more normalized ratio of days sales outstanding at the end of Q2 from 45 days to approximately 41 days. As we’ve said in the past and we’ll continue to state it going forward. This metric bill will continue to be driven by sales, timing of sales as well as product and customer mix.

And then on white goods, is it right to say like white goods may end up better than our expectations for this year. It didn't seem like in a you would kind of expected much worse at the start of the year it wasn't as bad, after first quarter it looks almost normal as we move into second quarter. So kind of, what's the outlook on pricing margins there?

We’re keeping our outlook as it was when we started the year and I think as we saw the compression, the first quarter we saw moderation in that compression in margins. In the second quarter what the dynamics that are driving that, the oversupply in the industrial market to the extreme competition in both of them. We see that continuing, so we’re not forecasting any improvement in that. We think this is - what happened in second quarter while we were pleased with it, we don't think it changes the overall outlook for those two products.

And then lastly just going back to the aged, I think I understand your commentary on the smaller players on financing and what have you, but I think in the past you had thought it would roughly go kind of the third, a third, a third to aged to the big mid and small size and at the same point we've had a - obviously there is a shortage of the market and I would think there's some pent-up demand for the age that you have available-for-sale. So can customers wait this thing out for six months and that's what I'm trying to - - have a tough time understanding how it gets pushed to next year, don't they need or can’t they monetize the inventory that's of age in the near-term?

I think there's some confusion, we talked about our sales in general being a third, a third, a third. We haven't given out our forecast on how the age would break out across those customers. But to your point I think we’re seeing three reasons making this - they' challenging to execute this on a timely basis, one is funding and I think is important for people to understand, it's not so much the size of the brand, it’s a strength of the balance sheet of that brand owner. Now certainly the multinationals nationals have - don't have that issue. Also we’ve hedged - at the end of the second quarter we hedged some sales that did not transact some because people - the customers didn't have their funding in place. Some because customers decided to use their funds for other pressing usages and sort of gamble that they would have the - that the inventory would still be there, the aged inventory from us would still be there when they needed it. And then as I said, I think some customers are - we believe might be starting to try to game the system and we’re seeing it will get feel the pressure. So I think we can initiate - this is - showing a learning curve here. We’re implementing an approach that's new to the industry and there's certainly a little bit of trial and error. We are seeing a general vacancy from most customers to contract far out into the future, so - - we the people are reluctant say last year to go ahead and contract for age for this year, so they want to make sure they need it and they want to make sure when they will need it. So they don't have to carry it. The size of our inventory and our public mission in communicating the size of that inventory might be giving customer's confidence that they're able to wait on it and still get it, certainly there’ll be a point that they actually needed. They needed almost - needed to put in the bottle. So for that reason we think the pace of sales will pick up as we get closer to their eventual need. We’ve talked about the illusion of scarcity. I think maybe our public pronouncements about the size of the inventory and the extensive inventory and maybe the slowness of our sales in the first half have drawn that and make our customers question that. But I think as we move into the second half of the year and we begin to transact these sales, as our customers get closer to their absolute critical need for this inventory that will firm up. And we'll continue to explore ways to make contracting more attractive to our customers without diminishing the value of this inventory. But it's very - even though we're six months into this, it's still a very new approach to the industry. We're surely learning a lot about it and continuing to adjust our approach to both sell inventory, but also continue to maximize the economic value. And again, we have not reduced our pricing. We are selling less volume metric but older whiskey, we continue to be very confident in the value of the inventory and I think proof of that is that we have said we are going to continue to build the inventory through 2019, where we had questions about the value of the inventory, we wouldn't be continuing to build that asset.

And then one last one, and not to put words in your mouth, but is thinking that you're putting a lower end to the range of the guidance, a way of signaling to customers that you're willing to wait it out and not going to be held up in terms of making near term sales?

Yes. In fact, we don't give quarterly guidance and the fact that we have indicated that there's a possibility we might not execute all the sales, yes, I think it would be a clear signal of that.

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

Wanted to ask about what you were just talking about with some of your customers having difficulty to access the capital and having to prioritize some of their own capital outlays? And I guess I'm just trying to understand, why would this be unique to the aged whiskey, particularly just given that I would imagine aged whiskey is purchased by your customers more close to when they're going to actually sell it as opposed to new fill? Is this an issue, customers may be having more sporadic purchases based on the timing of when they have cash coming in the door, is this an issue that's been impacting your new fill business as well? And is there any concern if it hasn't that that it could in the future?

Yes, so the aged little bit different from the new fill. Most customers are going to pay up front for it and the sheer size of the transaction, so they're going to - maybe they could parch their purchases of new distillate out over a time, that's sort of a planned supply chain. Whereas if they need the aged, they tend to buy in a lump because they address their specific need. And so that makes the financing a little bit more important. And as you said other uses, and I think that's - they used to buy it and now they're waiting. I think we're seeing a little bit more people waiting till they're absolutely sure they need it and getting closer to that critical moment when they need to put it in the bottle. I talked a minute ago about the delusion of scarcity. So I think people are saying; "Well, maybe I can put it off, maybe I can use my funds to build up my sales force, maybe I can use my funds to build up my visitor center and so forth. And I can gamble little bit on the availability, because I don't need it for another six months or I don't need it for another three months." But the looming need, the critical need for it is still out there. And as time goes by, we get closer to that, which makes the demand little more time sensitive.

That makes sense. And then if I could switch gears and ask about the food ingredients segment; looks like it had a pretty strong quarter despite the loss of that key customer at the beginning of the year. Have there been other customers that you've been able to add in the meat substitute categories? Obviously there's been a lot of attention on that space and a lot of growth. And just curios and it seems like your ingredient isn't the big one that went public recently. But curious if there have been other quickly growing brands that have replaced some of that business that you lost at the beginning of the year or what products and functions have really been driving that business for you lately?

Yes, we have added other customers. They seem to be growing quickly. Obviously the customer we lost had been ramping up for a while. So we lost somebody who was a little further along in the revolution, and the customers were gaining a little bit earlier in the revolution. But we are continuing to see - we're gaining actual customers who are ordering from us for their brand - their products that are growing. And we're continuing to see really strong interest across a range of applications. So the burgers get all the attention. But there is tremendous growth in application similar to chicken or pork or crab. Particularly, there's a lot of attention now on chicken nuggets and things like that. And so I think - so we are well positioned. We're working with a wide range of customers, we’re seeing strong interest in the applications, have acquired actual customers and that's why we feel so strongly about the long-term potential there.

That makes sense. And then looks like now a couple quarters in a row, your classic or commodity formulations have been showing some growth year-over-year. Just curious what's been driving that? I mean, it looks like in the past that was a much more sporadic kind of business when you would have revenue or are you starting to get more stable customers who are using those more traditional formulations in their products on a regular ongoing basis? Just would love to hear about perhaps how those segments have evolved as well.

Yes, I think there's two pieces that are important there. One, the growth in our commodity wheat proteins, some of that is a result of - because our TruTex textured, especially wheat protein, since we launched the customer for that product, those sales, the use in that particular product is softer. And so we still make the protein so we sell it as a commodity wheat protein. So some of the volumetric bump is due to that but we are seeing stronger interest from our customers in their clean label initiatives and our commodity wheat proteins and commodity wheat starches, some people also use the term 'Native', wheat starches and wheat proteins, are clean label. And so that demand is helping us achieve little higher margins on those products than has historically been true in the past.

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

Thank you all for your interest in our Company and for joining us today for our second quarter call. We continue to make progress towards implementing our long-term strategic plan and remain confident that it'll provide the resources we need to deliver growth in 2019 and beyond. We look forward to talking with you again after the third quarter.

The conference has now concluded. Thank you for attending today’s presentation. You may now disconnect. Enjoy the rest of your day.