MGP Ingredients' (MGPI) CEO Gus Griffin on Q1 2018 Results - Earnings Call Transcript

MGP Ingredients, Inc. (NASDAQ:MGPI) Q1 2018 Earnings Conference Call May 2, 2018 10:00 AM ET

Executives

Mike Houston - Lambert Edwards, Investor Relations

Gus Griffin - President and Chief Executive Officer

Tom Pigott - Vice President of Finance and Chief Financial Officer

Analysts

Bill Chappell - SunTrust

Alex Fuhrman - Craig-Hallum Capital Group

Francesco Pellegrino - Sidoti

Operator

Good day and welcome to The MGP Ingredients Inc., First quarter 2018 Results Conference Call and Webcast. All participants will be in listen-only mode. [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 finance results for the first quarter 2018. 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 the call up to questions. However, before we begin today's call it is my responsibility to inform you that this call may involve certain forward-looking statements such as projections of revenue, earnings and capital structure as well as statements on the plans and objectives of the company's business. The company's actual results could differ materially from any forward-looking statements made today due to a number of factors including with the risk factors described in the company's most recent annual and quarterly report 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 Web site www.mgp.ingredients.com.

At this time, I'd like to turn the call over 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 first quarter both of our business segments showed growth over the prior year driving consolidated net sales for the quarter up about 1% and net income increased almost 3%. We continued to be very pleased with our progress against all parts of our strategic plan and see no change in the macro consumer trends that are powering our growth. However, our results this period do reflect quarterly volatility resulting from changes in customer order timing for premium beverage alcohol in the distillery segment.

Since the initial implementation of our strategic plan in early 2015, this is the first time we've experienced a quarterly decline either versus prior year quarter or sequential quarter in sales of premium beverage alcohol. Despite that this quarter was still a very strong period for sales of premium beverage alcohol, our third highest in recent history.

Based on that, we are reconfirming our guidance for the full year, looking at each segment individually and our distillery product segment, net sales finished the quarter up 0.6%, while gross profit declined 4.5%, as the timing of premium beverage alcohol customer orders affected segment results.

Total food grade alcohol net sales declined 2.1% for the quarter with premium beverage alcohol sales down 3.4% from the prior year quarter. Despite this quarterly decline, we continue to experience strong demand for our bourbon and rye whiskeys and we continue to grow new distillery sales with existing and new customers.

We do not feel this year-over-year decline in sales of premium beverage alcohol this quarter reflects any slowdown in our core business. Also of note, sales of dry distillers' grains or DDG had a positive impact on our distillery product segment results in the first quarter growing 26.5% due to improved pricing. While we welcome the improved DDG sales results for the quarter, we do not view these results as a trend to the unchanged macro environment that led to lower pricing began in first quarter of 2017.

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 helping us attract and retain new distillery customers. Due to the continued robust growth in American whiskey, we continued to see strong demand for 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 to support our existing partnerships and to attract new customers for new distillery products. Even with these sales, we are able to increase our inventory of aged whiskey during the first quarter. Overall, we remain focused on the long-term and our plan for sustainable growth in premium beverage alcohol remains on track despite the volatility we experienced this quarter.

Turning to Ingredient Solutions. Net sales grew 2.7% while gross profit improved by 27% to $3.1 million for the quarter. Gross margins expanded 430 basis points driven by higher net sales in both our specialty wheat protein and specialty wheat starch businesses. This quarter versus prior year quarter sales of our Fibersym specialty wheat starch product grew substantially and sales of our TruTex specialty wheat protein products more than doubled. We are pleased with this continued sales growth confident in the macro consumer trends supporting this growth and excited about the potential.

In summary, we are seeing the key consumer trends affecting both business segments remain strong and there continues to be strong demand for our products. We continue to invest to take full advantage of the potential provided by these trends and the significant opportunities afforded by our long-term strategy.

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 0.9% to $88 million reflecting growth in both the distillery products and ingredients Solutions segments. Gross profit decreased 0.5% to $19 million as a result of the decrease in gross profit in distillery product segment partially offset by an increase in the Ingredients Solutions segment.

Gross margin decreased by 30 basis points to 21.5% of net sales from 21.8% in the prior quarter. Corporate selling, general and administrative expenses for the quarter were $8.6 million up approximately $900,000 primarily due to investments in the MGP's brands platform in both personnel costs and advertising and promotion.

Operating income for the first quarter decreased to $10.4 million compared to $11.4 million during the prior quarter reflecting the modest decline in gross profit and the investments in SG&A.

Our corporate effective tax rate was 12.3% in the current quarter compared to 24.7% in the prior year quarter, the primary reasons for the 12.4 percentage point decrease in our quarterly effective tax rate from last year are the impact of the Tax Cut and Jobs Act enacted in December 2017 and an increase in our share based compensation tax deduction. The share based compensation deduction was a key driver of the first quarter's low rate and is factored into our full year guidance.

Net income for the first quarter increased 2.9% to $8.9 million and earnings per share increased $0.02 to $0.52 per share driven by the favorable tax rate.

MGP's balance sheet remains strong allowing us to continue to invest to grow as well as return funds to shareholders. We've discussed the strong fundamental cash generating capability of our business which allows us to provide strong cash flows even as we continue to grow our library of ageing whiskey.

For the first quarter cash flow provided by operations was $900,000 or $1.8 million improvement versus the prior year quarter. This result includes the company's investment of a net $2.2 million towards growing our barreled distillery inventory for ageing.

We continued to have very good access to capital as of March 31, 2018, $139 million are made available under the $150 million revolving credit facility and $1.1 million of cash was on the balance sheet. Recently the Board authorized the second quarter dividend in the amount of $0.08 per share. The Board continues to view dividends as an important way to show the success of the company with shareholders.

As outlined in the press release this morning MGP is confirming 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 operating income growth in 2019 is 15% to 20% as sales of aged whiskey become a more significant factor.

2018 net sales growth is projected in the high single-digit percentage range versus 2017 subject to some volatility as the company continues to shift sales from industrial to premium beverage alcohol. 2018 margins are expected to continue to grow modestly versus 2017 and 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 concluding remarks.

Gus Griffin

Thanks Tom.

Now I'd like to touch on some additional initiatives to support our long-term strategic plan. We continue to invest to grow in our distillery segment. We have now spent $28 million of the $33.8 million capital approved for our warehouse expansion program. This appropriation is scheduled to be completed in 2018. We are currently assessing industry trends and working with customers to determine if further investment is warranted. We certainly have the resources to continue to expand as needed.

In addition, our inventory of ageing whiskey has now reached $67.9 million of cost. We are continuing to work on the optimal strategies and refining our approach to deploying this inventory to drive stronger operating income growth in 2019. While our core focus in the distillery product segment will always be supplying other brand owners with premium distilled spirits. We continue to be pleased with the progress of our brands initiative.

During the first quarter, we launched our current portfolio of premium spirit brands in Illinois, Colorado and Arizona. In addition, we were honored to receive the Chairman's Trophy and a 97 rating for our Remus Repeal Reserve Straight Bourbon whiskey at the Ultimate Spirits Challenge. George Remus Straight Bourbon whiskey earned a 94 rating until American wheat vodka earned a 93 rating at the same competition. These results further validate MGP as a producer of the highest quality premium spirits and provide further momentum for our brands initiative.

Expanding our brand portfolio has been a key strategy and I am now proud to announce that we'll be introducing two new Rye whiskies this month. [Raw Spill Union] [ph] master crafted straight rye whiskey and [Raw Spill Union] barrel proof straight rye whiskey will soon begin shipping to retailers and our existing markets.

Crafted for smooth character and superb cocktails master crafted is a 94 proof Rye Whiskey aged over four years. Barrel proof is bottled at a 112.6 proof with a border flavor and it is aged over five years. Both were produced at our legendary Lawrenceburg distillery which was established in 1847 and originally named Rossville distillery. These two introductions leverage our significant experience and expertise with rye whiskey provide us with an entry into the fastest growing segment of the American whiskey category and position us for a long-term growth.

Safety and sustainability are both key components of our strategic plan. This quarter, we begin implementing an enhanced comprehensive employee driven safety initiative entitled safety up to raise our safety practices to the next level and make safety a more integral part of our culture. We also demonstrated our commitment to sustainability with the launch of two new initiatives. The first is a major renewable energy initiative whereby we committed to sourcing 100% of our electricity needs from renewable wind power. This three year certified program represents a significant step in our efforts to realize both the direct and overarching benefits of renewable energy technologies.

The second sustainability initiative we recently undertook was the elimination of all Styrofoam and single use plastics at our company facilities. These items have been replaced with compostable and biodegradable alternatives. These two initiatives will benefit our employees, our communities and our planet.

We are also continuing to explore and invest in additional initiatives to reduce water usage, emissions and waste in our facilities. As demonstrated by these initiatives, we are well positioned in the market and remain focused on our key strategies over the long-term. Despite quarter-to-quarter volatility, we remain confident that focusing on these strategies will drive 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.

Question-and-Answer Session

Operator

We will now begin the question-and-answer session. [Operator Instructions] Our first question comes from Bill Chappell with SunTrust.

Bill Chappell

Thanks. Good morning.

Gus Griffin

Good morning, Bill.

Bill Chappell

Yes. Gus, I guess the question is on really on timing obviously in the quarter, but two things, one what would the sales have been without selling lately aged just would've been down 5%, 10% just trying to understand that, and then, how big that was in the quarter? And then also, with regards to the timing, is this something that is really just pushed from one quarter to the next quarter are you seeing customers really move orders to the increasingly to the back half of a year?

Gus Griffin

Great question. I think it's really helpful to understand the nature of our customer base. So we have big customers and we have small customers. We have customers who have strong cash flow and can buy when they want to. And then, we have other customers who may work once to put together their financing. We have ones that have take regularly scheduled orders every quarter and then we have customers who are more sporadic. And then, finally, we have customers who were taking standard product that we routinely make and then we have customers who are doing special ordering.

And so all of those combined to cause a lumpy -- cause lumpiness on a quarterly basis. On a full year basis, it eventually smoothes out. But it would not be uncommon for us to be working with a customer say back in November and they may still not replace their order in the first quarter because they are trying to get their financing together or other logistical issues they might have had.

So despite the quarterly bumpiness on a full year basis, we feel we have a clear view to achieving our guidance.

Bill Chappell

And then, in terms of the lightly aged was that a meaningful part of the sales this quarter?

Gus Griffin

We're still not prepared to break that out because it varies. And again, it's usually tied -- it's tied to us attracting and retaining customers. So there might be a new customer who we sell a year old or 18-month old, at the same time there might be another customer we sell six month old which come with different prices. So it's both a price and a volume variable. But what I will say is, we have seen no decrease and no change in the strong demand for our aged product, in the pricing that we can demand for both our new distillate and our aged product.

Bill Chappell

Okay. And then, just asking any change in kind of customer count, any losses anything there because I'm right in saying most of this is -- your customers are ordering product that won't be actually drinkable for two to four years. So I mean in terms of the timing…

Gus Griffin

That is a great point because you have customers -- so we are really four years away from the end consumer. And so you might have customers who routinely bought new distillate that are waiting to see other brand plays out and then may turn around and want to buy one year old to fill that gap in the future. But in terms of customers, we added substantial customers this quarter and we are on track based on our year-to-date our first quarter rate of adding new customers. We're on track to add more customers this year than we did last year and last year we added substantial number of customers.

Bill Chappell

Great. And then, last one for me, just on the warehouse expansion and the thoughts there are you running into any bottlenecks, do you think you're going to need to materially expand from here or kind of where do we stand/

Gus Griffin

Yes. As we have said in the past, as you go along you earn more and you get a better view of the industry. We still have approximately 5 more million dollars to implement. And as we go through that we'll get a better view. So we're assessing the trends we're talking with our customers what their long-term views are. I'll say as we're assessing that situation and are ready to make a call on that this time.

Bill Chappell

Got it. Thanks so much.

Operator

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

Alex Fuhrman

Thank you for taking my question. I wanted to ask about the Food Ingredients Solutions segment another quarter of really strong results there and it sounds like the Fibersym and TruTex in particular have been really taking off. I guess we would love to get a sense of what is the runway for growth for those two products. I mean are these in the early innings of what could be much larger business lines for you? And then, the gross margin line in particular being above 20% for the first time in a long time for ingredient solutions. Is that perhaps sustainable as those core specialty products start to take up a larger share of the segments revenue or was there something in the quarter that perhaps gave that a little bit of a onetime gross margin boost?

Gus Griffin

First, let's talk about the runway. This is really being powered by strong macro consumer trends particularly for Fibersym, the consumer demand for more fiber in their diet. And then, on TruTex, of course, the really strong trend of interest in plant based proteins. So on Fibersym, of course, the patent expired last May. We have a -- what we consider a superior product, but we do eventually expect some price competition. We've been waiting for that and putting together our strategic plans on how to address that and how to continue the growth.

Despite that on TruTex, we again feel we have a superior product or wheat based product has a -- these are all benefits and more neutral color or more neutral flavor and better texture. And this trend just continues to accelerate, so we think there is substantial runway there.

In terms of the margins, as we…

Tom Pigott

I will just chime in on the margins, the overall strategy is moving us into higher margin products and that's where we're seeing our volume growth which is very good for the quarter. We were able to both increase pricing beyond a higher commodity cost which contributed to the margin growth in the quarter in ingredient solutions. Again overall our business can be choppy in terms of the contribution in margins, but we feel very good about the trend in that it's underpinned by growth in higher margin products.

Alex Fuhrman

Great. Thanks. That's helpful. And then a question about your new rye products that you're going to be launching. I'm just thinking about the other brands that you've launched over the last couple of years. Should we expect this to follow a similar cadence where it launches in a small number of states and then expands the route there or now that now -- now that you have pretty good distribution throughout the Midwest for your for your other brands, might we see the new rye product launching in all of those markets initially.

Gus Griffin

Yes. Thanks for the question, I should have clarified. The rye product -- both rye products will go into all the markets that we are currently in and that will be the pattern going forward when we develop and introduce a brand it will then go into the footprint that we're currently in. So where George Remus could only go into approximately five states because that's all we are, Union Rye products -- brands will go into our entire existing footprint. We will probably take -- that will happen over the next probably six weeks.

Alex Fuhrman

Excellent. Thanks Gus.

Operator

[Operator Instructions] The next question comes from Francesco Pellegrino with Sidoti.

Francesco Pellegrino

Good morning guys.

Gus Griffin

Good morning, Francesco.

Francesco Pellegrino

Thanks for taking the question. Just a question on the segment, I know it was briefly discussed in your prepared remarks, just about the segment margins within the distillery segment. I know it looks as if some strength in DDG really contributed to, I guess less of a fall off in margins than I would have anticipated with the increasing DDG revenue more pricing than volume significantly more pricing than volume?

Gus Griffin

Yes. We did -- so the key drivers of the distillery margin is you had the drop off in premium beverage alcohol sales which was a negative. And we continue to have pressure on industrial pricing and that was a negative but the positive was DDG and that that gave us a favorable impact on our distillery margin.

Francesco Pellegrino

Got it. I want to ask the question, what was the headwind in regard to the lower premium beverage alcohol sales, I'm not going to get that, but I guess a different way to just think about it is, your base business for distillery segments was really strong and I know you said it's probably not sustainable going forward. When I think about the premium beverage product line that you have, it looks as if it was just really a timing issue. And I know you guys don't really talk margin profile with your guidance. But we can probably see a pretty big pop in margins whenever this timing issue corrects itself whether it's in the second or third quarter. Is that the correct way to think about it? Not talking about like 100 to 200 basis point increase, I'm talking about something a little bit more sizable.

Gus Griffin

Well, I think when you started your question, you asked what were the headwinds. And I would say there were no headwinds. The overall market trends, macro trends, the health of all the brands that we supply everything is going along as we've projected -- as we've that's the basis of our business. So this wasn't a slowdown in the industry, a slowdown in our any particular customers. It was lumpiness in our orders and us going against average alcohol was up 30%. So we were going against an extremely difficult comp.

So again, I just -- there's no -- we don't see any headwinds here. And I think as we play out over the year and that's why we give you yearly guidance because of the lumpiness in the quarters. As we -- as that comes back you'll see that improvement.

Francesco Pellegrino

By headwinds I meant customer order headwinds, I know there's no fundamental issues with the macro economics.

Tom Pigott

Yes. I think the one thing to consider is the DDG margin -- benefit we've got on DDG. We've not stressed that's really sustainable. So there could be a scenario where as we -- as that order timing gets more favorable, the DDG doesn't necessarily maintain. And that's why we're -- our guidance is that we continue to expect to grow our margins modestly at this point as we get better visibility to how the year will play out both with commodities and DDG we'll be able to give it more visibility.

But certainly longer term as Gus mentioned, we do continue to believe that the demand for the premium beverage spirits we make, in particularly brown goods remains very strong. And the pricing will continue to be maintained and that as we deploy more aged whiskey in the future you'll see more margin growth.

Francesco Pellegrino

Got it. Just switching over to the ingredient solutions business. First, did you get rid off your commodity wheat protein product line? I know it wasn't much of a contributor, but…

Gus Griffin

No. That's a great question. One of our key strategies is maximizing the value of our production. So constantly trying to value up the lower value products, our commodity wheat protein is -- what's called white wheat gluten. And white wheat gluten is the key ingredient into TruTex, so that just means that we -- this quarter, we used all the white wheat gluten in TruTex, so we extracted the most value we could out of it.

Francesco Pellegrino

But this is the second consecutive quarter that you haven't had commodity wheat protein sales. So it just seems that you are slapping a brand on it -- a really strong brand on it and you might actually not be producing a private label commodity wheat, a highly commodity wheat protein products at a lower margin?

Gus Griffin

That's correct. We had technical expertise to turn it into a higher value product. So we are not -- white wheat gluten is very much of a commodity product. So we are not selling the commodity product, we're using all of that feedstock for lack of a better word and turning it into something that has technical -- we have added technical value, it's going into higher value products.

Francesco Pellegrino

Got it. When I just think about the business though for that product line volumes were actually down and you got this nice margin lift probably due to just this brand shift of taking something that was off brand to a branded product platform. With the volumes down, I'm just trying to wrap my mind around, if there was any manufacturing leverage any operating leverage or was this all price?

Tom Pigott

So, where the volumes were down, we're really on the commodity products, which are at the lower margin. And that's what drag down the overall volumes down to 6.4%. But from a margin standpoint -- certainly the facility ran well and we were able to price ahead of commodities and grow margins in the segment.

Francesco Pellegrino

Just two more questions for me. So I know you don't sort of break down what your operating profit growth is for each segment, but is this run rate sort of sustainable through the rest of the year, for the ingredients solutions segment.

Tom Pigott

We felt very good about the quarter for ingredients. We don't want to give any specific guidance in terms of the full year. Go ahead, Gus.

Gus Griffin

I mean again I'll reiterate the volatility -- quarter-to-quarter volatility. You look at our past quarters, you've seen lumpiness in both segments and so we may be going against a specific comp -- tough comp or easy comp. We may pick up -- maybe a quarter where we picked up new customers this year we picked up new customers last year. So I refer back to our belief in the strength of the overall macro trends ingredients particularly high fiber and plant based proteins. And then, our positioning of our products and we think we have superior products.

Francesco Pellegrino

I know you guys have done a lot of marketing in the past year for your ingredient solutions product line. All the ingredients solutions magazines that I've read that you're on like almost the back cover of everything. So I know a lot of effort has gone into it and I guess it's just probably pretty nice to see the return that you're getting right now.

Gus Griffin

Yes. It is very nice. We've put a lot of work in over the last couple of years on this -- on TruTex. So recovering from a misstep several years ago and we identified this macro consumer trend we believe that it had had a lot of growth potential. And so we made the investment -- the time -- the time and the capital and the money investment to position ourselves to benefit from it and so now -- it's really -- it is very gratifying to see it pay out and we think it's got great potential.

Francesco Pellegrino

And then just the last question for me about the financials, your balance sheet, you guys have leveraged that about at least how I calculate it, 0.6x trailing 12 month adjusted EBITDA really conservative, look you doubled the dividend, I know you're constantly looking at M&A, you're looking at branded products, we're going to be coming -- you're going to be having this significant investment in capital expenditures during 2018 that's going to fall off into 2019. You'll continue to use cash flow to build your inventory up so that you're better positioned for higher margin sales in the future. However, at some point that inventory build will sort of just -- I would think reach a sustainable level or consistently grow as you're generating even more cash.

At some point, what's the conversation about what you could potentially do within under leverage balance sheet currently or a potential cash build going forward because all of those things that I just tossed out at you. There's a lot of little things that you guys are doing right that sort of incrementally increasing leverage, but I don't see you jumping in and sort of you're saying what we're really going to get it behind growing our brands and we're really going to invest in them. There's a lot of small acquisitions, there's nothing really out there that you guys have significantly done to sort of increase leverage whether it was a share repurchase authorization when the stock was at $30 or $40, it's now at $90 maybe mid 80s today. I'm just wondering what priorities are going to be going forward.

Gus Griffin

Sure. Great question, so from -- overall we're not going to lever up for leverages sake. We feel good about having a strong balance sheet. That said, we have some great investment priorities, one, continue to build that aged whiskey that's ageing for future growth and we expect to continue to invest and build that balance over the year.

We'll continue to add warehouses as we see appropriate those are very strong return investments. And then, we -- certainly you mentioned the brands and if we see an acquisition that we feel will fit well into our existing platform that it meets our criteria. We certainly will consider it and because we view that platform as a great long-term investment for shareholders.

And then, last, our approach has been to return funds to shareholders in the form of dividends. And you did see us cut a special dividend last year after we sold ICP. So that's the overall capital strategy. And over time, again, we're not going to lever up for leverage to sake, we feel good about the balance sheet today, but should we continue to have great growth opportunities, we have the flexibility to invest.

Francesco Pellegrino

All right. Gus said everything I thought. Thanks again guys.

Gus Griffin

Thank you.

Operator

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

Gus Griffin

Thank you for your interest in our company and for joining us today for our first quarter call. We are certainly pleased with the continued strength and momentum we have experienced and look forward to talking with you again after the second quarter.

Operator

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