MGP Ingredients, Inc.
Q4 2020 Earnings Call Transcript

Published: 27 Feb 2021

[Operator:]

Good morning and welcome to the MGP Ingredients Fourth Quarter and Full Year 2020 Financial Results Conference Call. Please note this event is being recorded. I would now like to turn the conference over to Mike Houston, Investor Relations. Please go ahead.

[Mike Houston:]

Thanks, Gary. Good morning, everyone. I am Mike Houston with Lambert and Company, MGP’s Investor Relations firm. And joining me today are members of their management team, including Dave Colo, 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 up to questions.

[Dave Colo:]

Thank you, Mike and thank you all for joining us. On this call, we will provide an overview of our results for the quarter and year, updates on key financial performance metrics and a discussion of progress against our strategy. Then we will take your questions. 2020 represented a solid year of improved effectiveness in our tactical execution while accelerating the pace of our strategic implementation. Our objective to optimize brown goods profit by increasing volume share at market based pricing paid dividends as gross profits for the Distillery Products segment and company finished the quarter and year at record levels. Additionally, our ability to improve throughput and profitability in our Ingredient Solutions segment resulted in an increase of 97% in gross profit for the year. Consolidated sales for the year increased 9%, while gross profit increased 29.1% to a record $98.8 million, representing 25% of consolidated sales. Reported operating income increased 14.8%, while adjusted operating income increased 20.9%. We are very pleased with the continued momentum by each of our segments this quarter, reflecting strong growth for the year. Each quarter this year posted a record gross profit result versus the respective prior year’s quarters, and the fourth quarter was no exception. Aged whiskey sales experienced another record quarter, which drove an 11.4% increase in premium beverage alcohol sales for the year, also a record. Specialty ingredients sales posted strong double-digit growth for the quarter and grew 19.2% for the year. Looking at each segment individually, in our Distillery Products segment, fourth quarter sales increased 7% and was primarily driven by a 28.2% increase in brown goods sales. Full year sales of premium beverage alcohol were up 11.4%, with record sales of aged whiskey being the primary catalyst for growth. Aged whiskey sales also served as the primary driver to the increase in gross margins in the period. The average age of barrels sold was the highest it has been since we began making these aged whiskey barrels available for sale to our customers in meaningful quantities. Our growth in sales of brown goods this year has outpaced the longer term market trends. This was primarily due to increased demand from national and multinational customers as they filled gaps in their aged brown goods inventory levels. Sales of new distillate for the year declined slightly from last year as we experienced more demand for aged whiskey as compared to new distillate, which we also believe was driven by some of our customers leveraging our aging whiskey inventory as a solution to fill gaps in their inventory.

[Brandon Gall:]

Thanks, Dave. For the quarter, consolidated sales increased 9.1% to $100.9 million as a result of double-digit growth in both premium beverage alcohol and the Ingredient Solutions segment. Gross profit increased 47.2% to a record $31.7 million due to improved segment gross profits in both the Distillery Products and Ingredient Solutions segments. Gross margin increased by 810 basis points to 31.4%. For the year, consolidated sales increased 9% to $395.5 million due to Distillery Products and Ingredient Solutions segment sales growth. Gross profit increased 29.1% to a record $98.8 million as a result of higher Distillery Products and Ingredient Solutions segment gross profits. Gross margin increased by 390 basis points to 25% through 2020. Also impacting gross margin results for the year was the ransomware cyberattack that temporarily disrupted production at our Atchison facilities during the second quarter. While no financial information was affected, and there is no evidence that any sensitive or confidential data was improperly accessed or extracted from the network, it is estimated that this attack adversely impacted gross profit by $1.7 million during the second quarter, of which, $633,000 was recovered through a business interruption insurance claim in December 2020. We are currently evaluating our ability to seek further recovery related to this event.

[Dave Colo:]

Thanks, Brandon. This year marked an inflection point of implementing our long-term strategic plan, which has delivered substantial improvements to our financial results and build a strong foundation for future growth. A critical part of that foundation was positioning MGP to benefit from the robust growth of the American whiskey category. Two key components of this effort have been our inventory of aging whiskey and accelerating our branded initiative. As Brandon mentioned, our inventory of aging whiskey declined $3 million from the third quarter to $105.4 million at cost at the end of 2020, reflecting strong sales of aged whiskey and reduced putaway of whiskey. We believe our library of various mash bills and vintages will continue to contribute significant levels of profit and cash flow for the company. We also took a material step towards accelerating our branded initiative through the recent Luxco definitive merger agreement announcement. This acquisition, which is expected to close in the first half of this year, significantly expands our product line in the higher value branded-spirits sector and increases our sales and distribution capabilities across all 50 states. Importantly, the transaction is expected to improve MGP’s gross margin and cash flow generation profile, and we expect EPS to be low to middle single-digit percentage accretive in the first full year following its close, excluding onetime transaction expenses. This combination is consistent with our ongoing strategy to shift the company’s focus into higher value-added products. It will provide an immediate material increase to MGP’s scale in the branded-spirits sector establishes an additional platform for future growth and significantly diversifies our business. There are many reasons to be excited by this acquisition all of which are expected to provide sustainable growth opportunities, which benefit our various stakeholders. During this past year, we were fortunate to strengthen both business segments with key hires. The Ingredient Solutions R&D team was strengthened by the additions of a Vice President of R&D, a culinary chef and a principal food scientist, each have experience in specific disciplines that will enhance MGP’s role in helping customers succeed with fast-paced new product development in areas of high demand from consumers, such as plant-based proteins and dietary fiber. In our Distillery Products organization, we recently created a lead master distiller role, which will support our strategy of developing bench strength and collaboration among MGP’s team of master distillers and master blenders, allowing us to efficiently serve customers of any size. And lastly, we have expanded our export sales team to include an individual based in London with more than three decades of experience in European markets. Each of these key additions to the MGP team, have collectively strengthened our ability to execute on our long-term strategic plan. Although we believe the strengthened team and our proven ability to execute our long-term strategy this past year will lead to sustainable growth opportunities, we have identified three potential headwinds for 2021, we wanted to proactively share. The first potential headwind relates to increased commodity costs. As you may be aware, during the past several months, there have been significant increases in corn exports from the U.S. as well as downward revisions to the 2020 corn crop yields and stocks, resulting in higher corn costs. As a reminder, we employ an extensive risk management program that includes purchasing the corresponding grain, at the same time, we contract volume and pricing for our products. However, for various reasons, we do not contract 100% of our sales. And as a result, we cannot provide assurance that we will always be able to price through increases in commodity costs to our customers in the open market. Second is the historic severe cold weather conditions that have occurred in the Midwestern corridor of the United States in recent weeks. As a result of these weather conditions, we were required by our energy suppliers to reduce natural gas usage at our Atchison operations for approximately 2 weeks. This impacted our distillery that produces grain neutral-spirits and industrial alcohol, as well as our ingredients facility, which produces wheat-based proteins and starches. This disruption in production will likely result in a reduction to revenue and earnings for the first quarter, we are in the process of restoring service levels to our customers as a result of this historic event. Finally, like many other businesses that sell goods internationally, ours too is experiencing issues with backlogs at various shipping ports as well as shortages for shipping containers needed to deliver our products abroad. While these logistical issues are likely the result of the global supply chain disruption caused by the COVID-19 pandemic, it is unclear how long these delays and issues will persist. Similar to 2020, this year is presenting numerous challenges to our business. However, demand for our products remains robust, and we believe our business continues to be well positioned to mitigate these challenges through the balance of the year. While the COVID pandemic brought with it accelerated growth for certain parts of our business, it also continues to bring increased uncertainty during these unprecedented times. While we remain very confident about the long-term potential of our business, we anticipate continued uncertainty related to the pandemic throughout the year. As a result, it continues to be difficult to predict with any level of precision, the pandemic’s cumulative impact on our future financial results. For these reasons, we are not providing 2021 annual guidance at this time, and we’ll reassess this position based on the visibility of the macroeconomic recovery. Despite these changing dynamics, we believe the underlying macro consumer trend supporting the ongoing growth of the American whiskey category remains strong. Notably, we rolled out our Remus Repeal Reserve Series IV Straight Bourbon Whiskey during the fourth quarter, while also debuting single barrel programs for our George Remus and Rossville Union brands earlier in the year. While still small, total annual sales for our brands grew as expected by solid double-digit growth rates in 2020. We believe our brands are well positioned for additional growth in 2021 as we integrate with Luxco’s marketing and sales teams and gain access to their national distribution capabilities following the close of the transaction. Our focus on continually refining the effectiveness of our tactical execution, accelerating the pace of our strategic implementation and leveraging the strong foundation we have built has positioned MGP for sustainable long-term growth. Finally, I would like to thank all of our employees for their dedication and actions that delivered outstanding results in a year full of challenges and opportunities. That concludes our prepared remarks. Operator, we are ready to begin the question-and-answer portion of the call.

[Operator:]

Our first question comes from Bill Chappell with Truist Securities. Please go ahead.

[Bill Chappell:]

Thanks. Good morning.

[Dave Colo:]

Good morning, Bill.

[Bill Chappell:]

Hey, I just want to start kind of push back on the no guidance. I mean, we’ve seen pretty much every consumer-facing company give some level of guidance for 2021. And I understand we’re still in a pandemic, but I’ve got to think visibility is improved at least over the past 6 months to give you some kind of guide, and you’re also a business that kind of has an order pattern from customers that you can see. And so give me some more color why this business is so different and why the visibility is so poor that you can’t give some initial guidance? And if you can’t give guidance, can you at least tell us do you expect the business to grow in 2021 versus 2020? Because as we are looking at an accretion number out of Luxco, just kind of trying to figure out what the base we’re talking about.

[Brandon Gall:]

Yes. Bill, this is Brandon. I’ll start off on that and a couple of things. In the spirits industry, not all of our peers are giving guidance. In fact, some are still refraining for the exact reasons that we shared. Additionally, some of our big profit drivers, primarily in our brown goods side of our business. The order patterns are not always highly visible. We’ve been very clear on that with investors over the course of the last couple of years. So although 2020 was a record year for that part of our business, just do the inherent order patterns of our customers. It does not give us any added visibility as we go into this year.

[Dave Colo:]

Bill, I think the other thing is, as we get into this year, we’ve got the Luxco acquisition to close here in the first half of the year. I think we need to get through that process as well. Take a look at what’s going on in the environment post-close and then reassess our view on guidance for the balance of the year at that point in time.

[Bill Chappell:]

So is there a chance that your ex-Luxco earnings to be down this year? I mean, there is always a chance. But I mean, is that what you’re seeing that there is some risk to numbers or just directionally trying to understand, you seem very bullish on a lot of opportunities, but it’s again, tough for us to get our arms around where things are going?

[Dave Colo:]

Yes. No, I think that’s a fair pushback. But I think for all the reasons Brandon stated, we’re just not going to give guidance at this point in time, Bill. We do still continue to believe we’ve got tailwinds in both our Ingredients business as well as our Distillery Products segment. In the past, we’ve said we expect to grow in line with category growth rates in those particular segments. We still feel good about that. And like I said, I think we’ll be in a better position post-close on the Luxco transaction to assess if we think that’s the appropriate time to provide guidance or not.

[Bill Chappell:]

Okay. Well, turning to one area where I’m pretty sure you have very good certainty on the industrial alcohol side. I think you said that’s pre-sold a year in advance, and it runs at capacity. And I also believe that you went through the kind of pricing negotiations and contracts over the past quarter. So can you give us an update of where that stands? Because I think there was an expectation that there would be higher margins and higher overall profitability with just the increased demand for hand sanitizers, wipes from your customers?

[Dave Colo:]

Sure. Yes, we have pretty much completed the pricing cycle in Q4 of last year on industrial alcohol. Keep in mind, Bill, we do not price or contract 100% of our volume. We leave a certain percentage open for the spot market for various reasons. We did see improved pricing during that contract cycle like we thought we would. What we anticipate playing out this year, and I think we have talked about this on the last couple of calls, if there is new capacity that’s come on to the market in industrial as well as GNS capacity it started coming on the market in the second half of last year. There is new capacity that’s going to come on this year. So we do think that’s going to suppress pricing as the new capacity comes into the market. We are seeing a little bit of reduction in demand as COVID goes on longer and longer. I think people bought a lot of inventory that rolled out in the form of hand sanitizer and other cleaning products, if you will. And if you notice in the stores now, there is an abundance of hand sanitizer and alcohol products, etcetera. So long story short, we were able to get better pricing. We think the spot markets are probably going to start to decline through the balance of the year due to the increased capacity, but we should see some improvement in our industrial margins for the year.

[Bill Chappell:]

Okay. And then just to the brown spirits on the aged inventory, with the Luxco deal expected, how does that change your view on the aged use of the aged inventory? I mean, at one point, you had a plan to kind of work the inventory down, which I think is still moving forward. But to the level which you want to move it down, does that change? And when I say that, I know you’re not making or I don’t believe you’re making any of the Luxco brown spirits for them. But you certainly have an opportunity to either

[Dave Colo:]

Yes. It’s a great question. I think the way we look at is the highest and best use of the inventory. So obviously, the best use of it is in our own brands. But as we’ve talked about historically, we have put away whiskey to support the growth of our own brands and we will continue to do that. We remain obviously very committed to having enough putaway to support our existing customers’ needs as well. And with Luxco post-close, we definitely will be looking at opportunities. There could be opportunities to come out with new brands that we develop that can use our liquid. Luxco, as you know, Bill, their whiskey brands are all primarily Kentucky-based whiskey. So we have – they have adequate distillation capacity at this point to support their own brand’s needs. However, if we want to launch new brands post-close with Luxco, we certainly have the capability to do that with our current inventory levels.

[Bill Chappell:]

Okay. And then last one for me. Just any more color on just the timing of the Luxco? You said first half. I mean, should we assume that safely sometime in the second quarter? I didn’t know if there was anything that – why it would take 6 months to close, it seems fairly straightforward transaction?

[Dave Colo:]

Yes. I mean, it’s the typical things you have to go through. This deal is going through the HSR process as we speak. And we have to go through a number of regulatory matters with the TTB in the states on licenses and permits. So we’re deep into that process. We certainly don’t see anything at this point in time that would prevent this deal from closing. We’re moving as quickly as we can, and our goal is to close as quickly as we can. So there is nothing at this point, Bill that we see to prevent that.

[Bill Chappell:]

No roadblocks. Okay, great. Thank you.

[Dave Colo:]

You bet. Thank you.

[Brandon Gall:]

Thanks, Bill.

[Operator:]

The next question is from Alex Fuhrman with Craig-Hallum. Please go ahead.

[Alex Fuhrman:]

Great. Thanks very much for taking my question. Dave, you mentioned in the prepared remarks that your sales team has really changed strategy. It sounds like a whole different approach to selling whiskey that has been successful. Can you talk a little bit more about that? And in particular, I mean, it seems like for years, the company has had a really good stockpile of aged whiskey. And the issue has been less about the value of the inventory and more about the business of actually selling it. Now it looks like you have two quarters in a row where you’ve been able to get a good number of transactions executed for aged whiskey. Is that going to be the norm now going forward? Can you talk a little bit more about the changes in your sales process and what we should see going forward?

[Dave Colo:]

Sure. Yes, Alex, I think we talked about the change, if you will, in our selling process for, I think, the last three, four quarters now. And yes, it’s definitely gaining traction. And we’ve had a number of new customers come into the fold, a couple of pretty significant multinationals have come into the fold in the last couple of quarters here and bought aged. And we think what’s really driving that. It is the combination of the kind of the subtle changes we’ve made in our go-to-market with our brown goods, but also just the increased demand that we’ve seen over the past 12 months in whiskey. And part of that, obviously, it’s driven by the great marketing that all of our customers do with their whiskey brands and the continued increase in interest from consumers. But I think we’d be naive if we didn’t think part of it was also due to the changes that we saw with COVID and the move to much more off-premise sales and a reduction in on-premise. And that, I think, has benefited some of the larger American whiskey brands. And I think we benefited from that as they needed to fill some gaps in their aged inventory as they saw, probably demand higher than they expected, primarily probably over the last 6 to 9 months. But yes, I think overall, we still feel we have plenty of aged inventory. We’ll continue to manage that and put away what we think is the appropriate amount on a quarterly basis to support our customers’ needs and any future demand that we think is going to be out there.

[Alex Fuhrman:]

That’s helpful. Thanks. And then as you think about what you just mentioned with a lot of your bigger customers kind of making some of these catch-up purchases to fill holes in their inventory. I mean you guys deal with so many different customers. I imagine you have a pretty good view into sort of the overall landscape. Do you feel that top whiskey brands have sufficiently caught up or is there still room in their inventory that they are going to need to fill in 2021?

[Dave Colo:]

Yes. I mean, as you know, Alex, our customers don’t tell us that. So that’s part of what creates the uncertainty that Brandon was speaking to earlier about visibility of customer order patterns. But I can tell you what we’ve seen play out this past year is, if you’ll recall when the pandemic first hit and on-premise locations were shut down, it really impacted the craft distillers. And we saw a significant drop-off in the amount of activity – of selling activity with our craft customers. As the year progressed, and we started to see this in Q3 and then it continued in Q4, we have seen a resurgence in craft distillers needs for aged inventory. So I think that’s a good sign. I think that will probably continue if on-premise continues to reopen. And if the vaccines continue to be successful and the cases of COVID continue to decline, there is no reason not to expect that. So that’s a good trend, I think, that we are starting to see emerge. But as far as knowing if our kind of the multinational and national customers, have purchased enough inventory at this point to fill their gaps, it’s hard to predict that.

[Alex Fuhrman:]

Okay, fair enough. Thanks. And then my last question is, I guess, in the release, you guys break out specifically some of the onetime costs around the management transition and the M&A due diligence. Can you give us a little bit more color on the financial impact of the fire and your Atkinson facility? Is the net impact to results, I think you mentioned getting or having a record for an insurance settlement in the numbers, so is the net impact to the results, the $4.5 million you called out minus the insurance settlement? And just where might we see that show up in the numbers?

[Brandon Gall:]

Yes. Good question, Alex. So to answer the last one first on the dryer, you got it exactly right. So the $4 million in change gross profit impact we saw from the dryer was offset by the receipt of roughly $3.5 million. And you will see that play out at the gross profit level. So that’s where you’ll see that. Again, we were able to receive the insurance recovery in the period, which is great from a timing perspective and a reporting perspective we are going to strive to do the same in future quarters until we get our new dryer operational. But a lot – as I already mentioned, some of that’s not going to be totally within our control. Some of the other items you mentioned, so in the quarter SG&A, moving away from the dryer, Alex. SG&A in the quarter increased about $10.9 million. About – this is broken out towards the back of our press release, but about $1.5 million of that increase is due to the CEO transition and Luxco deal-related costs. The vast majority of the remainder is incentive comp related. So – and that’s driven by two things. Firstly, not reversing out the incentive accrual as we did in the prior year; and secondly, increasing the accrual in response to the company’s performance in 2020. So as we also mentioned, once we get past the first half of this year with additional transaction expenses we expect to incur, we do expect SG&A to normalize in the back half.

[Alex Fuhrman:]

Okay. That’s helpful. Thank you.

[Operator:]

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

[Dave Colo:]

Thank you for your interest in our company and for joining us today for our fourth quarter and full year call. We look forward to talking with you again after the first quarter. Thank you.

[Operator:]

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