MGP Ingredients (MGPI) Q3 2019 Earnings Call Transcript

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MGP Ingredients (MGPI -1.19%)
Q3 2019 Earnings Call
Oct 31, 2019, 10:00 a.m. ET

Contents:

• Prepared Remarks
• Questions and Answers
• Call Participants

Prepared Remarks:

Operator

Good day, and welcome to the MGP Ingredients conference call and webcast. [Operator instructions] Please note, this event is being recorded. I would now like to turn the conference over to Mike Houston, investor relations. Please go ahead.

Mike Houston -- Investor Relations

Thank you, Shantel. 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 2019. I'm Mike Houston with Lambert & Company, MGP's investor relations firm, and joining me today are members of their management team, including Gus Griffin, president and chief executive officer; and Brandon Gall, vice president of finance and chief financial officer. We will begin the call with management's prepared remarks and then open the call up to questions.

However, before we begin to call, it is my responsibility to inform you that this call may involve certain forward-looking statements such as projections of sales, operating income, gross margin and effective tax rate 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 anybody 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 -- President and Chief Executive Officer

Thank you, Mike, and thank you all for joining us. On this call, we will provide an overview of our results for the quarter, updates on key financial performance metrics and a discussion of progress against our strategy. Then we'll take your questions. Now I will turn to the results for the third quarter.

While the overall American whiskey market remains robust and our position within that market is still very strong, timing and volatility of customers' orders continue to be a challenge this year. As in previous quarters this year, we saw forecasted orders delayed due to customer funding issues and their desire to delay purchasing as long as possible. These issues have affected sales of both new distillate and aged whiskey inventory throughout the year. Despite this, we did have a very strong quarter for sales of aged whiskey, selling both more whiskey and older whiskey as customers continue to need our inventory to launch new brands, fill holes in their inventory and support brand acquisitions.

We believe these customer needs will be ongoing. While we are behind where we'd like to be at this point in the year, we're off to a strong start to the fourth quarter and we are confident in our line of sight to sales required to deliver against our full-year guidance. Looking at each segment individually. In our distillery products segment, sales for the quarter were down 6.4% to $73.3 million.

While sales of aged whiskey were very strong this quarter, sales of new distillate declined for the quarter as in addition to funding issues and timing delays. Some of our existing customers reduced orders versus the prior year to work through temporary excess inventory situations. We do not believe these changes in short-term order patterns are any indication of weakness in the health of the overall industry or our customers' businesses. Projecting out whiskey needs four or more years into the future is an uncertain science and sometimes corrections are needed.

While the decline in new distillate drove down sales of total brown goods for the quarter, we continue to realize pricing in line with our expectations for both new distillate and aged whiskey. Segment gross profit declined slightly to $15.9 million while gross margin improved to 21.7% of segment sales, reflecting the impact of more high-margin aged whiskey in the segment sales mix. The strength of our aged sales this quarter highlights both the demand for aged whiskey and our unique ability to meet that demand. The demand for aged whiskey is driven by our customers' desire to bring new brands to market sooner, fill holes in their inventory for their existing brands and support their growth aspirations for brands they acquire.

Our investment in building a large and broad library of aged whiskey has us well positioned to meet those needs and while we experienced some delays earlier in the year, we are now seeing the type of demand we anticipated when we initiated this investment. Our decision in 2015 to begin investing in putting away whiskey for aging was a key part of our long-term strategy. While we are now starting to see the sales piece of this strategy ramp up it is important to understand the success of this strategy to date in terms of customer recruitment and financial return. We believe our willingness to make significant strategic sales of white aged whiskey over the past few years has been instrumental in the development of our large and diverse customer base.

And we have achieved pricing in line with our 3x model as we have executed this strategy. Our aged whiskey inventory has us well positioned to meet future demand. We now believe that other than what is reserved to support the future growth of our own brands, we will have very minimal 2015 vintage inventory remaining at the end of the year. We are also confident that any remaining inventory from that year will continue to increase in value.

As we have said all year, sales of aged whiskey will be the key determinant of our ability to deliver against our full-year guidance and that continues to be the case. We are confident in our line of sight to those sales as we have either transacted sales or are in advanced discussions with specific customers for specific inventories for those required sales. We also continue to focus on the long term, working to improve our position in the market by constantly recruiting new customers, strengthening our relationships with existing customers and expanding our geographic sales coverage. We are doing an outstanding job recruiting new customers for our new distillate in aged whiskey offerings, adding more new customers this quarter than both the year-ago period and last quarter.

Recruitment is key to our long-term growth, ensuring we are exposed to all segments of the market. And we believe we now support over 300 new distillate in aged customers. We also work hard to develop long-term relationships with our customers and we recently signed a new multi-year new distillate supply agreement with one of our largest existing customers. We are also beginning to see sales results from our earlier investment to expand our international sales coverage.

We continue to view this as a key area for long-term growth and have now added a second dedicated sales manager to support that effort. Continuing on to other areas of the segment. Sales of premium beverage white goods increased 4.3% for the quarter, with margins holding about even with the prior-year period. Sales of industrial alcohol decreased for the quarter, down 5.5% with margins compressing slightly.

Both of these markets continue to be hypercompetitive and the chronic oversupply dynamic in the industrial market still exist. We expect this situation to continue for the foreseeable future. Sales of dry distillery grains or DDG, increased 12.4%, reflecting short-term micro factors. Our outlook for DDG pricing continues to be based on the unchanged macro environment that led to lower pricing in the first quarter of 2017.

Revenue from warehouse services increased 12%, reflecting in part, growth in the number of customer barrels aging in our whiskey warehouses and other services we provide. Turning to ingredient solutions, sales grew 4.2% to $17.4 million, while gross profit declined to $2.9 million or 16.6% of segment sales. We are very pleased with the overall progress in this segment as we achieved double-digit sales growth in both specialty wheat starches and proteins. While continuing to cycle the loss of a large customer for our Trutex textured specialty wheat protein product at the end of last year.

We continue to recruit new customers for this product and remain confident that it will be a driver of long-term growth. We also saw strong growth in our Arise specialty wheat protein product line this quarter. This product is used to increase protein in bakery and pasta items, targeting consumers who want to add more protein to their diets, while reducing their carb intake. This product line is also aligned with the clean label trend, allowing food manufacturers to improve texture and shelf life without adding chemical preservatives.

The FDA approval of our Fibersym in FiberRite specialty wheat starches also removed a major barrier to the growth for this product line and we are now seeing its potential. These products ideally suited to help brands develop healthier food offerings, delivering high-fiber content while lowering carbs, in line with the increased consumer interest in the keto diet. Overall, both our business segments continue to benefit from favorable consumer trends. We continue to see strong demand in pricing for our products and remain very confident, encouraged about the long-term outlook.

This concludes my initial remarks. Let me now turn things over to Brandon Gall for a review of the key metrics and numbers. Brandon?

Brandon Gall -- Vice President of Finance and Chief Financial Officer

Thanks, Gus. For the quarter, consolidated sales decreased 4.6% to $90.7 million, reflecting a decline in our distillery products segment, partially offset by an improvement in the ingredient solutions segment. Consolidated gross profit decreased 4.1% to $18.8 million as a result of gross profit declines in both the ingredient solutions and distillery products segments. Consolidated gross margin increased approximately 10 basis points to 20.7% of sales, up from 20.6% in the prior-year quarter.

Corporate selling, general and administrative expenses for the quarter were $7.2 million, down 5.2% versus prior year. The decrease was due to lower personnel costs, including reduced accrual for incentive compensation based on year-to-date performance and other cost-saving initiatives. This was partially offset by increased costs related to the company's agreement to pay a $1 million fine and an administrative civil penalty of $251,000 in connection with the chemical release incident in Atchison, Kansas in October of 2016. Excluding the resolution of those legal matters, we remain focused on effectively managing these costs while still investing to grow.

Consolidated operating income decreased 3.4% to $11.6 million compared to $12 million during the prior-year quarter, primarily due to a decrease in gross profit in both the ingredient solutions and distillery products segments, partially offset by the decrease in the previously described SG&A expenses. Our corporate effective tax rate for the quarter was 26.9% compared with 22.9% in the year-ago period. The increased rate as compared to the prior-year period was primarily due to the discrete tax impact of a previously described resolution of certain legal matters. Net income for the quarter decreased 8.8% to $8.2 million and earnings per share decreased to $0.48.

These decreases from prior-year results were primarily due to the decrease in operations and the change in income tax expense, as earlier described. We discussed the strong fundamental cash-generating capability of our business, which allows us to provide positive operating cash flows even as we invest in our inventory of aging whiskey. In the third quarter, cash provided by operations was $9.3 million. One driver of cash provided by operations was the reduction in accounts receivable during the quarter, reducing our ratio of days sales outstanding.

While we have seen a gradual reduction year to date of days sales outstanding, we expect this will ebb and flow due to the growth and evolution of our business and our customers, particularly as we develop longer sales histories with craft customers, new relationships with export customers and new long-term supply agreements such as the one Gus just mentioned. During the period, we also invested a net $9.7 million for growing our barrel distillate inventory for aging to meet the needs of our ever-growing and diverse mix of customers. Capital spending remains a key way we support our business growth plans. We have reduced our expected capital expenditures in 2019 to approximately $19.5 million due to the timing of certain projects within the warehouse expansion program.

Despite this change in timing, we continue to expect this $51.8 million warehouse expansion to be completed during 2020. MGP's balance sheet remains strong, allowing us to continue investing in our growth and drive long-term shareholder value. We continue to have very good access to capital. As of September 30, 2019, $149.5 million remained available under the $150 million revolving credit line.

Our capital allocation strategy remains consistent with prior quarters and years as we continue to build our aged whiskey inventory, expand warehouse capabilities and contemplate possible M&A opportunities that are consistent with our long-term strategy. Recently, the board authorized a third-quarter dividend in the amount of $0.10 per share. The board continues to view dividends as an important way to share the success of the company with shareholders. MGP is confirming the following guidance for fiscal 2019.

2019 sales growth is projected in the mid-single-digit percentage range versus 2018. 2019 gross margins are expected to increase modestly as compared to 2018. The company's estimate of growth in operating income in 2019 is 10% to 20%, inclusive of the previously described resolution of certain legal matters. 2019 effective tax rate is forecasted to be approximately 19% and shares outstanding are expected to be approximately 17 million at year-end.

Earnings per share are forecasted to be in the range of $2.55 to $2.75. Let me now turn things back over to Gus for concluding remarks.

Gus Griffin -- President and Chief Executive Officer

Thanks, Brandon. Now I'd like to touch on some additional initiatives that support our long-term strategic plan. Our long-term strategy has us well positioned in the market and aligned with strong macro consumer trends. We continue to make the necessary investments to deliver long-term growth.

We continued to expand our warehouse capacity during the quarter, bringing our total spend, to date, on the project to approximately $46.4 million of the $51.8 million budgeted for the project. As Brandon mentioned, we also invested an additional $9.7 million in our aging whiskey inventory. This brings our inventory of aging whiskey to $95.2 million at cost. We remain confident in the long-term value of this inventory and its ability to meet the needs of our ever-growing and diverse mix of customers.

While we will be selling aged whiskey from this extensive library of inventory, we plan to grow the value of this inventory at cost through 2019. We remain confident in both the demand and pricing for our aged whiskey as well as our plan for maximizing the long-term economic value. We continued to progress our brands' initiative and are pleased with the strong gains we have made in our current markets. As a result, we are now beginning to expand into additional markets with the addition of Connecticut, Maryland and Washington, D.C.

this month. We are seeing strong consumer acceptance of our core portfolio and great anticipation for our limited edition offerings that will be released next month. While we are not where we would like to be in terms of year-to-date operating income growth, we are confident in our ability to achieve our full-year guidance. Both of our business segments continue to be aligned with strong macro consumer trends and our strategy has us well positioned for longer-term growth that would drive superior, long-term shareholder value.

Operator, we are now ready to begin the question-and-answer portion of the call.

Questions & Answers:

Operator

[Operator instructions] Your first question comes from Alex Fuhrman, Craig-Hallum Capital Group. Go ahead, please.

Alex Fuhrman -- Craig-Hallum Capital Group -- Analyst

Great. Thanks for taking my question guys. My first question, I guess, is the reiterating of the full-year guidance, I mean, that would imply a pretty nice double-digit increase in sales here in the fourth quarter, along with a really nice increase in gross margin. Just wondering what you can tell us, Gus, about your confidence in that? I mean, it sounds like you've transacted some sales already here in October.

Can you give us a sense of how much of your anticipated Q4 sales has already been transacted? And for the sales that you anticipate for the rest of the year, again, can you just give us a sense of what gives you the confidence that we're not going to see this pushed out another quarter or two? Are these maybe larger customers or customers you've had a more long-standing relationship with? Just anything you can tell us about that would be helpful.

Gus Griffin -- President and Chief Executive Officer

Sure. As oppose to after the second quarter when we gave you the percentages by how much had been transacted and how much we're in discussions with and how much had been targeted with, we've progressed that quite a bit. And so now we're really down to about a dozen customers that we're dealing with. We are an active ongoing discussions with them, specific customers for specific inventory to deliver those sales.

The majority of them, the vast majority of them are existing customers. We don't need them all to come through. And -- so we feel very good about that outlook. And that's why we're so confident in our ability to reconfirm our guidance.

Alex Fuhrman -- Craig-Hallum Capital Group -- Analyst

OK, that's helpful. And then just kind of looking at the last three years, I mean, assuming you hit those numbers, Q4 revenue as a percentage of annual sales will have gone from about 25% in 2017, it's about 28% last year to probably more than 30% this year. Given that that's such a big shift, I mean, is there something about just the nature of customer purchasing that would lead us to believe that that trend will continue or at least continue to be that Q4 is the most important quarter.

Gus Griffin -- President and Chief Executive Officer

Well, I think it's -- we said that we were -- this is a new -- us adding structure to an unstructured market and taking this level of inventory, aged whiskey inventory to the market was something nobody ever done. So certainly, we got off to a little slower start than some people thought we would. We were sure how this would fall out in terms of a quarterly basis. And now in the third quarter, we saw sales more reflective of our -- how we thought it would go once when we started making this investment.

So we see a diverse mix of customers with very similar needs. They need it because they want to launch brands, they need it because they need to fill holes in their inventory and they need it because they want to support their growth aspirations for brands they've acquired. So we're seeing very similar needs that have always been there. It is just simply the timing of our customers' demand to fill those needs at this time, seems to be skewing to the back half of this year.

I don't know if that is any indication that year after year after year, it will continue to be the back half. I think it is more -- it just happens to be a coincidence that the customers, diverse customers with similar needs all are feeling that need now. And I also think, as our sales of aged had picked up, it has certainly heightened our customers' sensitivity to the scarcity of this very valuable inventory.

Alex Fuhrman -- Craig-Hallum Capital Group -- Analyst

OK. That's really helpful, Gus. Thanks for that. And then just lastly, if I could ask about the big increase in barrel distillate inventory here in the quarter.

I mean, it looks like that's really the most you've ever put away in any single quarter since you've been with the company. I mean, just kind of get a sense of how much of that is targeted investment to be selling three, four, five years down the road versus maybe just some of the new distillate sales you were hoping to get in the third quarter didn't materialize and so they're just typically on your balance sheet in September?

Gus Griffin -- President and Chief Executive Officer

No. Alex, we sit down at the beginning of the year and think about how much we want to put away strategically, a lot of things impact the actual quarterly put away. You've heard us talk in the past about what mash bills we're running. We put away some of our core standard mash bills, so it's depending on what we're running that can impact it.

And then certainly, what you're seeing is a net number. So depending on sales versus the actual number of barrels we put away, impacts that net number you're seeing. We -- again, we've said we're going to grow it through 2019. We feel very good about the level of inventory we're putting away to support future growth.

So I wouldn't read anything into our quarterly number. I would read it into our long-term intentions.

Alex Fuhrman -- Craig-Hallum Capital Group -- Analyst

OK. That make sense. Thanks very much.

Operator

[Operator instructions] 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 -- President and Chief Executive Officer

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

Operator

[Operator signoff]

Duration: 47 minutes

Call participants:

Mike Houston -- Investor Relations

Gus Griffin -- President and Chief Executive Officer

Brandon Gall -- Vice President of Finance and Chief Financial Officer

Alex Fuhrman -- Craig-Hallum Capital Group -- Analyst

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