MGP Ingredients, Inc.
Q2 2018 Earnings Call Transcript

Published: 6 Aug 2018

[Operator:]

Good morning. Welcome to the MPG Ingredients, Inc Second Quarter Results Conference Call. [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.

[Mike Houston:]

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 second quarter 2018. I am Mike Houston with Lambert, Edwards, 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, Finance and Chief Financial Officer. We will begin the call with management’s prepared remarks and then open the call up to questions. However, before we begin today’s call, it’s 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?

[Gus Griffin:]

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 will take your questions. Now turning to results, for the second quarter, both of our business segments showed growth over the prior year driving consolidated net sales for the quarter up about 3%, with net income increasing over 18%. We remain very pleased with our progress against all parts of our strategic plan and we are continuing to invest for growth. While the overall American whiskey category continues to be robust, we experienced some temporary softness in the first half as a few existing customers delayed or reduced orders due to having previously purchased adequate inventory to meet their near-term needs. We continue to expect that our focus on attracting new customers as well as our strong partnerships with existing customers will result in stronger revenue growth in the second half of the year and we are reaffirming our guidance for the year. Looking at each segment individually, in our distillery products segment, net sales finished the quarter up 2.8%, while gross profit increased 4.6%. Net sales of premium beverage alcohol and industrial alcohol were both down slightly, resulting in a 0.2% decrease in food grade alcohol from the prior year quarter. We remain focused on the long-term opportunities provided by our positioning within the distilled spirits industry. We continue to experience strong demand for our bourbon and rye whiskeys and our plan for sustainable growth in premium beverage alcohol remains on track for the balance of the year. Also of note, sales of dried distillers grains, or DDG, had a positive impact on our Distillery Products segment results in the second quarter, growing 40.8% due to improved pricing. While we welcome the improved DDG sales results for the quarter, we do not view these results as a sustainable trend due to the unchanged macro environment that led to lower pricing beginning in the first quarter of 2017. The gross margin benefit DDG sales provided to segment margin this quarter was partially offset by lower margins on industrial alcohol as that market continues to be oversupplied and extremely price competitive. We expect the industrial alcohol market to continue to be soft. Consistent with our long-term strategy, we continue to build our inventory of aged whiskey. The strategic intent of this inventory is to support the growth of our own brands and to attract and retain customers for our new distillate products. We were able to significantly increase our inventory of aged whiskey during the second quarter. Our investment in aged whiskey has now reached $73 million at cost. A portion of the sizable increase in Q2 reflects stronger anticipated sales of our premium American whiskey products in the second half of the year. Longer term, we are assessing the best approach to provide structure to very unstructured market for aged whiskey. We continue to have positive discussions with existing and prospective customers about the potential for this product. Despite the lower growth we experienced in the first half of the year, our projections for sustainable growth in premium beverage alcohol remain in line with our strategic plan. Turning to Ingredient Solutions, net sales grew 3.6%, while gross profit declined by 3.9% to $2.8 million for the quarter. Gross margins declined 140 basis points due to higher input costs as compared to the prior year quarter. The second quarter marks the seventh consecutive quarter of revenue growth for our Ingredient Solutions segment. We are pleased with this continued sales growth and our focus on leveraging the key consumer trends of high fiber, high protein, non-GMO plant-based proteins and clean label ingredients is fueling this growth. We continue to strongly believe in the potential 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?

[Tom Pigott:]

Thanks, Gus. For the quarter, consolidated net sales increased 2.9% to $88.3 million, reflecting growth in both the Distillery Products and Ingredient Solutions segments. Gross profit increased 3.3% to $19.4 million as a result of gross profit growth in the Distillery Products segment partially offset by a decline in the Ingredient Solutions segment. Gross margin remained flat at 22% of net sales quarter-over-quarter. Corporate selling, general and administrative expenses for the quarter were $8.3 million and remained flat versus the prior year. Increases in personnel costs primarily to support the brands platform and other personnel costs were offset by savings in professional fees. Operating income from the second quarter increased to $11.1 million compared to $10.5 million during the prior year quarter. The 5.9% increase reflects growth in gross profit during the quarter as well as the leverage we achieved on SG&A. Our corporate effective tax rate for the quarter was 30.6% compared to 31.6% for the prior year quarter. We expect our tax rate to decline from this quarter’s rate during the second half of the year consistent with our full year guidance. Net income for the second quarter increased 18.2% to $7.5 million and earnings per share increased 18.9% to $0.44 per share from the prior year quarter. These quarterly results were driven by improved performance from operations, the absence of an equity method loss from ICP, which was divested in July of 2017 as well as a lower effective tax rate. As a reminder, we will be lapping the gain from the successful sale of ICP next quarter. MGP’s balance sheet remains strong allowing us to continuing to invest for growth and drive long-term shareholder value. We have discussed the strong fundamental cash generating capability of our business, which allows us to provide positive cash flows even as we invest in our inventory of aging whiskey. Year-to-date, the operating cash flow was $1.2 million, which includes the $7.3 million net addition to our aging inventory at cost, $5.1 million of this increase incurred during the second quarter. As Gus mentioned earlier in the call, the sizable increase in our inventory reflects stronger anticipated sales of our American whiskey products in the second half of the year. We continue to have great access to capital to lever for additional growth opportunities like our warehouse expansion program. As of June 30, $130.7 million remained available under the $150 million revolving credit line and $2.3 million of cash was on the balance sheet. Recently, the board authorized a second quarter dividend 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. As Gus previously stated, MGP is reaffirming 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 become a more significant factor. 2018 net sales is projected to grow 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 grow modestly versus 2017. The 2018 effective tax rate is forecasted to be 25% and shares outstanding are expected to be approximately 16.9 million at year end. Now, let me turn things back over to Gus for his concluding remarks.

[Gus Griffin:]

Thanks, Tom. Now I would 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 continue to invest to take full advantage of key consumer trends and we are now pleased to announce that based on the continued strong demand for our premium American whiskeys, we are making significant additional capital investments in our barrel warehouse program. Our projected investment in this program has been increased to approximately $51.8 million in capital expenditures, up from approximately $33.8 million. Our initial expansion plan more than doubled our warehouse capacity. This next phase will more than triple our original warehouse capacity. 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 June 30, 2018, we had incurred approximately $32 million of the total investment. We anticipate completion of this project by the end of calendar year 2020. As I have mentioned in previous calls, our core focus in the Distillery Products segment will always be supplying other brand owners with premium distilled spirits. We strive to be the supplier of choice for all brand owners and continue to implement initiatives to strengthen our positioning in the craft segment. Recently, we announced that we were lowering our minimum for custom mash bills. Previously set at 1,000 barrels, we have lowered it to 250 barrels to be in reach of more craft customers. By providing easier accessibility and more custom options, we believe we will become an even stronger partner to this key growth segment. We also continue to be pleased with the positive momentum we are experiencing on our brands initiative and in particular, our recently launched Rossville Union Rye whiskeys. Our brands continue to win top accolades for their outstanding quality, including recently earning gold medals across the board at the Craft Competition International and Remus Repeal Reserve being named Best of Show at the prestigious North American Bourbon and Whiskey Competition. The strong ratings and awards each of 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. For the remainder of the year, our focus will be on increasing distribution and sales velocity in our existing markets. As demonstrated by these accomplishments, we are well-positioned in the market and remained focused on our key strategies over the long-term. We remain confident that 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:]

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

[Bill Chappell:]

Thanks. Good morning.

[Gus Griffin:]

Good morning, Bill.

[Bill Chappell:]

Gus, obviously the focal point is premium beverage and just kind of the, I guess the weakness into the second straight quarter. And several questions I guess, this seems to be a little bit more of a surprise that it’s lingered. I know you didn’t expect it to come roaring back in the second quarter, but that it’s lingered this long. So, I guess what gives you confidence that it will? I mean, you are kind of implying a pretty big back half. Are you seeing orders quarter-to-date or you had some firm commitments that give you confidence in that? And then is there any capacity issue that you would have in terms of this many orders or this much of the business coming in the second half?

[Gus Griffin:]

Yes. At the Analyst Day, we had signaled that we thought the bulk of the growth or the recovery or the rebound whatever you want to call it would happen in the second half. So it wasn’t really that much of a surprise we thought they are. We focus on the long-term. And so orders, you are never exactly sure when they are going to come in, but we thought most of it would happen in the second half. So, we feel very strongly that we are still on track to deliver against our guidance on that. In terms of capacity as I noted, we put away what we had as excess capacity in the second quarter to go ahead and put away more whiskey so that we would be in position to meet what we project to be more robust growth in the second half of the year, so that we basically utilize the excess capacity to be in position to meet with the projected demand.

[Bill Chappell:]

So you probably won’t put it away as much of your own in the back half, it will be focused on customer orders, is that the right way to read that?

[Gus Griffin:]

Yes, exactly.

[Bill Chappell:]

And then in terms of – if I am looking at kind of a rolling 12-month, is there any sense that maybe there was some pull-forward in ‘17 of some of these orders instead of kind of on a calendar annual rate, there just were a lot of orders in the back half of last year that kind of took away from some orders in the first half of this year?

[Gus Griffin:]

No. As we called out in the press release, we don’t comment on our individual customers, their specific business, but we did have a couple of existing customers who either reduced their orders versus our projections and we think that’s temporary. And we also had some people who just sort of pulled back for the year to reassess what their business model was and how their brands were doing and so forth and we strongly believe those are temporary. We strongly believe that we are still the supplier of choice for them. We did not lose them to somebody else. It was just them reassessing, taking a breather and reassessing their inventory needs and we think it’s temporary.

[Bill Chappell:]

And then on this subject please last one. If I look on kind of your guidance for the second half or your thoughts on the second half, is it weighted any more towards fourth quarter versus third quarter? And I am assuming it doesn’t include selling any of your aged inventory this is just basically on un-aged sales on the back half?

[Gus Griffin:]

I think it’s been about probably five quarters now. We have said we do sell some lightly aged product. It’s for strategic purposes. It’s to attract and retain customers for our new distillate product and we will continue to do that. In terms of how this would be weighted towards the quarters, we have shied away from giving quarterly guidance and that’s where I would fall in, but we believe we are going to have a good, strong second half and that we will be able to deliver against our guidance.

[Bill Chappell:]

Okay. And then the last one for me, just more commentary on the ingredients side, just kind of the quarter-to-quarter choppiness?

[Gus Griffin:]

Yes, you want to handle that?

[Tom Pigott:]

Yes. So I think we are referring to the margins being down this quarter. What we are seeing is higher wheat costs. Now, we had priced ahead of it. So, we expanded margins in Q1. And now as we are absorbing some of those costs, the margins contract, but overall, we are confident in growing that business and maintaining and growing its margins.

[Gus Griffin:]

Yes. I think we are really pleased about there while there is some margin difficulties because of the input costs, this is our seventh consecutive quarter of revenue growth in ingredients and that was a long-term turnaround. And we are very, very pleased with how that has turned around and the sustained growth we have had in that business.

[Bill Chappell:]

Got it. Thanks.

[Operator:]

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

[Alex Fuhrman:]

Thank you very much for taking my question. Wanted to ask about the expansion of your warehousing program, I mean clearly over the last couple of years since you announced the first expansion, you have taken up your targets in terms of how much you are investing in that a couple of times. This seems like a particularly large increase and would love to hear sort of either your thoughts on the category or the needs of your customers and how that has changed today versus what you were thinking maybe 3 and 6 months ago?

[Gus Griffin:]

Yes. I think as I referred to a couple of times, the further out you go or as time goes by you get a little smarter, you get a little bit better view and so we did have those sort of small incremental increases in the program. And now as we have worked out our long-term plan and projections of the market and so forth, we thought it was time to go ahead and make a substantial increase in that program. So, it’s obviously a big investment one that we think is going to take care of our warehouse needs. We think this will be the vast investment we have to make in it and so we want to – and as that you go ahead and put together a master plan to get you to that number as opposed to sort of incrementalizing your way there. When you think you have a clear view to what you ultimately need, you go ahead and put a master plan together and that’s exactly what this plan is.

[Alex Fuhrman:]

Thanks, Gus. That’s helpful. And can you give us a sense of how full your current warehouses are? Do you anticipate that you are going to be needing or in a position to use this extra capacity in real-time as it’s becoming available to you between now and 2020?

[Gus Griffin:]

Yes. Hopefully, we are not quite in the position where we were in the past, where we test the floor to see if it’s dry before we roll the barrels in, but yes, this is going to be – definitely, we will be doing these on a consistent basis and we will be utilizing them as they become available.

[Alex Fuhrman:]

Terrific. And lastly Gus, it sounds like obviously some big wins in terms of reviews and ratings on some of your new products, can you give us an update on when you would expect those brands to start having a little bit more of a contribution financially?

[Gus Griffin:]

Yes. As I have said in the past, this is a very long-term initiative. We know this is where we need to go as a company to supply long-term growth, but it’s a long-term initiative. We are very pleased with everything we have seen. We are pleased with the support we are getting from our distributors. We are pleased with the performance of our sales and marketing team. We are pleased with the distribution we are getting and velocity, but it just takes time to build that velocity with consumers. So, that’s where we are going to focus on now is continuing to build the distribution in the markets we are in, continuing to focus on building that sales velocity at retail and then we will continue to expand from there. So I guess we are very pleased with it, but I want to make sure everybody understands, this is a very long-term initiative. So, I don’t think we will see a hockey stick anytime soon where this is going to start significantly impacting our financials.

[Alex Fuhrman:]

Thank you, Gus.

[Operator:]

This concludes our question-and-answer session. I will now turn the conference back over to Gus Griffin, President and CEO for any closing remarks.

[Gus Griffin:]

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

[Operator:]

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