MGP Ingredients' (MGPI) CEO Gus Griffin on Q3 2017 Results - Earnings Call Transcript

MGP Ingredients, Inc. (NASDAQ:MGPI) Q3 2017 Results Earnings Conference Call November 2, 2017 10:00 AM ET

Executives

Mike Houston - IR, Lambert, Edwards

Gus Griffin - President and CEO

Tom Pigott - VP of Finance and CFO

Analysts

Alex Fuhrman - Craig-Hallum Capital Group

Grant O'Brien - SunTrust

Francesco Pellegrino - Sidoti & Company

Operator

Good day and welcome to the MGP Ingredients Inc., Third Quarter 2017 Results Conference Call and webcast. All participants will be in listen-only mode. [Operator Instructions] Please note, this event is being recorded.

I'd now like to turn the conference over to Mr. Mike Houston, Investor Relations. Please go ahead.

Mike Houston

Thank you, Andrew. 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 2017. I'm Mike Houston with Lambert, Edwards, MGP's Investor Relations firm. And joining me are members of their management team, including Gus Griffin, President and Chief Executive Officer; and Tom Pigott, Vice President of Finance and Chief Financial Officer. We will begin the call with management's prepared remarks and then open up the call to questions.

However, before we begin today's call, it is my responsibility to inform you that this call may involve certain forward-looking statements, such as projections of revenue, earnings and capital structure as well as statements on the plans and objectives of the company's business. The company's actual results could differ materially from any forward-looking statements made today due to a number of factors, including the risk factors described in the company's most recent 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. On this call, we will provide an overview of 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. Overall, our third quarter results reflect our continued progress implementing our long-term strategic plan. Results in both Distillery Products and Ingredient Solutions showed solid growth over the prior year. Total net sales for the quarter increased 8.1% over last year, driven by 8.5% increase in our Distillery Products segment and 5.8% gain in Ingredient Solutions.

Gross profit for the quarter increased 23.2%, and gross margins expanded 270 basis points, both driven by strong results in our Distillery Products segment. Reported operating income declined 9.1% as a result of items recorded in other operating income in the third quarter of 2016. Excluding those items, our year-to-date operating income growth is at the high-end of our full year guidance.

Looking at each segment individually, in our Distillery Products segment, we continue to see strong demand for our premium beverage alcohol. This demand reflects the strength of underlying market trends particularly for American whiskey and our success attracting and retaining customers for a range of whiskey, vodka and gin offerings. Our goal is to build strong long-term partnerships with our customers.

And while we don't disclose our customers, the fact that our largest beverage alcohol customer just ordered us as their supplier of the year demonstrates the progress we are making in this area. Total food grade alcohol sales grew 11.1% driven by a 16.1% increase in sales of premium beverage alcohol. As we continue to strengthen our focus on and shift our product mix towards premium beverage alcohol.

While the demand for our products remained strong, our margins continue to reflect downward pressure from soft global pricing conditions for our distillers feed co-product or DDG. Sales of distillers feed and related co-products declined 16.3%, with pricing reflecting the supply demand dynamic created earlier in the year by China's increased tariffs on imported DDG.

Despite this headwind, gross margins expanded 430 basis points and segment gross profit grew 33.5%, reaching $16.5 million for the quarter. Consistent with our long-term strategy, we continue to build our inventory of aged whiskey. In addition to using this aged whiskey to support the development of our own brands, it is also used to strengthen our market position and our ability to attract and retain new distillery customers. Due to the robust growth of the American whiskey category, we continue to see strong demand for lightly-aged whiskey as customers seek to fill inventory gaps driven by higher-than-expected consumer demand.

We continue to leverage limited sales of lightly-aged whiskey inventory to support our existing partnerships and to develop new customers for our new distillate products. We remained focused on our long-term strategy of building our inventory of aged whiskey and even with the sales we increased that inventory to $58.6 million at cost at the close of this quarter.

Turning to Ingredient Solutions, quarterly revenues grew 5.8% driven by a 17.9% increase in sales of our specialty wheat proteins. This reflects the continued progress in developing our TruTex textured protein business, which is strongly aligned with the increased consumer interest in plant-based proteins. We also saw a nice increase in our Fibersym business, though with some softer pricing as expected due to the pattern expiration earlier in the year.

For the quarter, gross profit declined 23% to $2.1 million primarily due to decreased plant efficiencies. We view these lower plant efficiencies as temporary in nature. Despite the decline this quarter, segment gross profit is up 8.8% year-to-date.

That concludes my initial remarks. Let me now turn things over to Tom Pigott, for review of the key metrics and numbers. Tom?

Tom Pigott

Thanks Gus.

As Gus discussed this quarter featured strong revenue growth in both segments which was supported by our focus on our key growth platforms. Overall, we were pleased with the company's performance during the quarter. For the quarter, consolidated net sales increased to 8.1% to $86.3 million. Gross profit increased 23.2% to $18.6 million reflecting strong gross profit results in the Distillery Products segment.

Gross margin increased 270 basis points to 21.6%. We continue to invest in SG&A to build out our MGP brands growth platform. For the quarter, our SG&A expense was up $1.2 million over the prior year quarter reflecting growth in personnel cost, professional fees as well as advertising and promotion.

Third quarter operating income was $10.5 million, the prior year quarter included $3.4 million in other operating income from a favorable litigation settlement in asset sale gain. I should underline that our guidance for operating income in 2017 versus 2016 excludes us prior items and as Gus discussed year-to-date operating income growth finished the third quarter at the high-end of our full year guidance.

As previously announced on July 3, we can preview the sale of our equity interest in Illinois Corn Processing or ICP. This quarter's results include a pretax equity method investment gain of $11.4 million as a result of the sale. This transaction contributed $0.44 to our earnings per share for the quarter.

Our reported tax rate was 34.6% in the current quarter compared to 19.5% a year ago. The change in rate from the prior year quarter was primarily due to the adoption of the accounting standard ASU 2016-09 that provided the company with a tax benefit related to accounting per share based compensation during the third quarter of 2016.

Net income for the third quarter increased 48.3% to $14.1 million and earnings per share was $0.82 per share reflecting both the net gain on sale of ICP and improved operating performance. The company's balance sheet remains very healthy, for the sale of ICP received $9 million in cash proceeds before transaction fees and taxes and $14 million promissory note.

On September 15, the note was paid- off and MGP received a total of $14.3 million including principal interest and a final working capital adjustment. The $9 million in cash and the $14.3 million in note proceeds were reflected in this quarter's cash flow which included a $22.8 million return of equity investment.

Also related to the transaction the company declared and paid a special dividend of $0.85 per share, a total payment of $14.6 million. MGP finished the quarter with a debt balance of $34.2 million and $7.1 million of cash on the balance sheet. Also during the quarter, the company announced a new revolving credit facility and term loan agreement. These agreements will allow MGP to continue to grow and further scale the business in the future. At the end of the quarter, the company had approximately $137 million available on its credit facility.

Recognizing that the company has strong cash flow from operations, a healthy balance sheet and favorable access to credit markets, the board announced today our fourth quarter dividend in the amount of $0.04 per share. On an annualized basis, this represents a $0.16 per share dividend, the cash dividend program reflects the Board's and management's belief that our demonstrated financial strength will persist in the future periods and it is an important way to share the success of the company with shareholders.

MGP is in a strong position to continue to deliver on its guidance. Operating income is expected to grow between 10% and 15% annually from 2016 through 2018. This guidance excludes the gain from sale of equity, interest in ICP and the gain from a favorable litigation settlement and asset sale gain recorded in the third quarter of 2016.

Recognizing the difficulty of projecting three years into the future, our conservative estimate of growth in operating income in 2019 is 15% to 20%, sales of aged whiskey inventory become a more significant factor.

Moderate growth is expected in net sales in 2017 subject to some volatility as the company continues to ship its sales from industrial to beverage alcohol. 2017 gross margins are expected to continue to grow versus 2016, the 2017 effective tax rate is now forecasted to be 29% and shares outstanding are expected to be approximately $16.8 million at year end.

We would provide updated guidance for 2018 and beyond with our fourth quarter and year end earnings report.

Now, let me turn things back over to Gus for concluding remarks.

Gus Griffin

Thanks Tom.

We are pleased with both our results and the progress we made against our strategic plan during the quarter. We continued to maximize the value of our production focusing on premium beverage alcohol and our distillery product segment by expanding our premium beverage alcohol product offerings, capabilities and sales coverage.

In our ingredient solution segment, our plant based protein platform continues to gain traction. We are excited about the macro consumer trends benefiting both of our business segments and we continue to work to take full advantage of them.

We are also laying the foundation to capture a greater share of the value chain with our brands initiative. While still very early, we continue to be pleased with our progress in developing both our organization and our brand portfolio. We continue to implement our narrow and deep strategy building our existing brand portfolio including Till American Wheat Vodka, George Remus straight bourbon whiskey and Tenner's Creek blended bourbon whiskey in a limited number of market.

Additionally, our new limited edition Remus Repeal Reserve will be available later this month. Introduce to celebrate the Repeal prohibition on December 5, Remus Repeal Reserve would debut on November 13, the birthday of George Remus, the legendary king of the bootleggers.

We continued to invest for growth by building our inventory of aged whiskey and implementing our warehouse expansion program. We look to complete this program on time and under the initial budget with the completion of a warehouse in Williamstown, Kentucky next year.

We continue to focus on our key strategies over the long-term and although we may experience quarter-to-quarter volatility, we remain confident that focusing on these strategies would drive superior long-term shareholder returns.

That concludes our prepared remarks. Operator, we are ready to begin the question-and-answer portion of the call.

Question-and-Answer Session

Operator

We will now begin the question-and-answer session. [Operator Instructions] The first question comes from Alex Fuhrman of Craig-Hallum Capital Group. Please go ahead.

Alex Fuhrman

Great. Thank you very much for taking my question and congratulations on a really strong quarter here. I wanted to ask about, it sounds like a lot of your -- I think your customers are really been accelerating their growth and you alluded to on the conference call, some of them starting to effectively make catch-up purchases for some whiskey that they had under invested in over the last couple of years.

Can you give us a sense of, how much that dynamic played into the strength here in the quarter and as you think about perhaps your biggest customers and how short they might be on whiskey over the next two or three years? Can you give us a sense of how much progress they have made in catching up? Would it be fair to assume that in the third quarter here, they made a good progress catching up by accelerating your purchases or do you think that still lies mostly in the future?

Gus Griffin

Alex, I think, first of all, I think the underlying trends continue to be very strong. And then, so you see -- choosing is going on. You see a growth on everybody's brands. And then, you see the M&A activity go on. So, whether it's a complete purchase or whether it's just a investment stake puts more capital into those players pockets, so they can fill those gaps.

So, I think you are going to continue to see it go on because the -- both because of the underlying trend and then because of those other factors I mentioned as they get to capital along the way whether it would be required or just an investment. They will continue to try to fill those gaps.

Alex Fuhrman

Great. Thanks Gus. That's really helpful. And then, if I could ask a follow-up on just the status of the warehouse upgrades you made. It looks like over the course of this year, you have added close to $8 million of barrel. Just a lid also seen a big increase in the warehousing revenue you get from customers, how much room is there to house more whiskey, both your own whiskey on your balance sheet as well as customer purchases that are being aged in your facility and as you kind of build and grow over the next couple of years. How do you balance the two in terms of priority for space being able to serve your customers versus being able to stockpile more of your own whiskey?

Tom Pigott

That's good Alex. This is Tom. So, overall, we are balancing a number of factors the customer demand for new distilled, our warehouse capacity, the sales of lightly-aged whiskey in terms of how much inventory we are building on the balance sheet. And the current project is now forecasted to be $28 million in CapEx. And we expect it to be completed in 2018.

Now, we certainly continue to monitor the overall landscape in terms of our capital program and where we want to invest. And the overall trend as Gus mentioned are bullish. So, it's something that we are continuing to look at ongoing.

Alex Fuhrman

Greta. That's really helpful. Thanks Tom.

Operator

The next question comes from Bill Chappell of SunTrust. Please go ahead.

Grant O'Brien

Hi. This is actually Grant on for Bill. We just had a question maybe on the inventory, it didn't seem to grow as much as our expectation. So, maybe some more color on that dynamic whether some of that roll-off was lightly-aged or if it's more fully aged now with the expansion of that George Remus brand, just more color there would be great. Thank you.

Gus Griffin

Grant, as Tom said, there was a couple of factors that impact that. I think the -- what's really important to focus on in terms of our inventory build is -- we are committed to building that long-term that is part of our or a key part of our strategic plan. And quarter-to-quarter numbers are just that. I think I really look at -- where we are going long-term. We are committed to making sure we can supplier our own brands. We are committed to make sure, we can build strong partnerships and that's where we are focusing on.

Grant O'Brien

Okay, great. And then, just a second question on your branded portfolio maybe how you are feeling about that right now potentially other brands out there maybe expanding into January another White Spirits offering, just thoughts there?

Gus Griffin

Yes. We continue to look at M&A, what I think is really important to look at how far we have come over the last year. We are sitting here a year ago, we would have had one brand and one person, I think. And so, we've really done a great job, I'm very, very pleased with the progress we've made, building out organization and the brand portfolio as it stands now.

We have taken a very steady as it goes approach to it, narrow and deep focus on market expansion. You will see us continue to expand markets. You will see us continue to build out our organization over time as it is appropriate for our level of success and our growth.

So, we are going to continue to look at M&A, but you will see us, keep this in the right perspective.

Grant O'Brien

Okay, great. And then, just actually one more question, on the industrial alcohol segment, it seems like that business may have bottomed here, is that safe to assume or would we expect more of a shift here going forward as you focus more on that premium beverage alcohol.

Gus Griffin

So, the focus -- we've definitely shifted and won't change that shift in focus to premium beverage alcohol. We will continue to run the plant to get -- the best utilization of that plant as we can and do the best job we can with industrial alcohol on a very challenging market.

So, the fact that it -- it's going to be continue to be choppy, the inherent nature of industrial alcohol, is it's over supplied. So, I do not try to read too much into it bottoming out or the 1% growth, the slight growth this period versus the decline before. I think what you should take away is, our focus continues to be squarely on building our business in beverage alcohol and then doing the best we can to get plant utilization with industrial alcohol.

Grant O'Brien

Great. Thanks so much.

Operator

The next question comes from Francesco Pellegrino of Sidoti & Company. Please go ahead.

Francesco Pellegrino

Good morning guys.

Tom Pigott

Good morning.

Gus Griffith

Good morning Francesco.

Francesco Pellegrino

So, I wanted to gain a little bit more into all your distillery segments, just I don't really understand some of the dynamics. So, your volumes were up 7% margins up very strongly by 400 basis points, when I look at or use as a read through, the distillers speed revenue which was down 16% while spot market prices were up -- were down 25%. Is the read through, is that a majority of your -- the increase in your volume was distributable to greater distiller feed sales?

Tom Pigott

Not necessarily. No. We saw nice growth across the entire platform. Now, obviously distillers feed is kind of -- it's a co-product to our manufacturing process. So, it will move the actual volume in distiller feed. We will move with the rest of the complex. And unfortunately with the pricing softness we experienced, it was an unfavorable impact on the quarter, it impacted the Distillery margins in the quarter by about a 190 basis points. So, that continues to be a challenge for us, the distillers feed pricing dynamics that we've talked about in the past. And we'll start to wrap around that in Q1 of next year.

Francesco Pellegrino

So, given the elevated headwinds that you're experiencing from the lower spot market prices or distillers feed, obviously as you start to tap in a little bit more to some of the premium barrel distiller that has sort of offset pretty well the margin pressures from the distillers feed. I guess is there a way you could sort of give us a little bit of color maybe its in regards to what your utilization rates are in regards to production of premium beverage alcohol, because I know the inventory number that we see as been decelerating. But I would think your production cost are actually decreasing as well, which I am not sure if maybe overall volume barrel distiller volumes are up on a sequential basis or a year-over-year basis. So maybe you could help us frame out a better understanding of where your inventory position is, you don't have to go into the layers?

Tom Pigott

Yes. I would say broadly we were happy with the continued growth in premium beverage alcohol and, as Gus, as we talked about the put away number can be influenced by our customers demand for new distillate as well. And so, we're certainly focused on supporting our customers and assessing the situation and growing with them. The other thing that certainly helped us this quarter is we did have in distillery we did have some lower input costs, lower corn and that was slightly offset by the lower pricing in industrial as well as the DDT we mentioned. So, that's also playing into what you're seeing in terms of the margin profile for Distillery on the quarter.

Gus Griffin

Let me just add, we also saw very strong demand across beverage alcohol, so we're not going to break, once a year we'll break out the white versus brown, but for both white and brown we saw really, really strong growth and that's how it impacts, what we can put away on a short-term basis with the back of the DDG, that is just a function of production. So I wouldn't get too, as we've signaled it's the pricing soft we'll wrap around it in the first quarter and I think that's probably the best way to treat it.

Francesco Pellegrino

All right, perfect. Thank you so much.

Operator

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

Gus Griffin

Thank you for your interest in our company. We look forward to talking with you again after the fourth quarter.

Operator

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