MGP Ingredients, Inc. (MGPI) Earnings Call Transcript & Summary

Good morning, and welcome to MGP Ingredients, Inc. announces definitive merger agreement with Luxco. [Operator Instructions] Please note that this event is being recorded. I would now like to turn the conference over to Mike Houston. Please go ahead.

Good morning, everyone, and thank you for joining the MGP Ingredients conference call and webcast to discuss the company's announcement of a definitive agreement to acquire Luxco, Inc and affiliated companies. I'm Mike Houston with Lambert and Co., MGP's Investor Relations firm. And joining me today are members of their management team, including Dave Colo, President and Chief Executive Officer; and Brandon Gall, Vice President of Finance and Chief Financial Officer. We will begin the call with management's prepared remarks on the transaction 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 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. Along with the press release issued today, a comprehensive presentation deck and fact sheet have been prepared, all documents can be accessed at the company's website, www.mgpingredients.com. At this time, I'd like to turn the call over to MGP's President and Chief Executive Officer, Dave Colo. Dave?

Thank you, Mike, and thank you all for joining us to discuss the announcement of our definitive merger agreement with Luxco. Clearly, we're excited by this opportunity and the expected positive near and long-term potential that it offers for MGP. I'll begin my comments this morning with a broad overview of the deal. Afterwards, Brandon will summarize the transaction financials, and then we'll open the call to questions following my closing prepared remarks. The definitive merger agreement with Luxco presents a unique opportunity to take a material step towards realizing our long-term strategy. It will enhance our product offering by adding a leading beverage alcohol company across various categories. And an enterprise with a storied history reaching back to its founding in St. Louis in 1958. This deal is consistent with our ongoing strategy to shift the company's focus into higher value-added products. It will provide an immediate material increase to MGP's scale in the branded spirits sector that establishes an additional platform for future growth and significantly diversifies our business. We consider this a significant value creation opportunity to acquire a unique and attractive national spirits platform. This deal is financially attractive, and we expect the transaction to be immediately accretive to our gross margins, EPS and free cash flow generation as described in the GAAP reconciliation included in the appendix to the investor presentation. The acquisition reflects the total enterprise value of $475 million and is expected to be financed by 5 million shares of MGP common stock with the remainder payable in cash. Luxco has built a strong distribution platform with sales and distributor representation in all 50 states and a dedicated international sales team, which will provide additional growth opportunities in the future. The company is both a leading distiller and importer of spirits across various categories, including bourbon, tequila, Irish whiskey, Gin, vodka, portals, liqueurs and creams. For the 12-month period ended October 31, 2020, Luxco generated net revenues of approximately $202 million and 9 liter case volume of $4.8 million. Luxco has an attractive portfolio of fast-growing premium distilled spirits brands as well as strong cash flow generating legacy brands. Their products cover a wide range of price points with the premium brands representing approximately 46% of Luxco's net revenue. We are acquiring a solid and comprehensive range of brands that Luxco has developed over the past 60 years, and we see significant opportunity to leverage this market position for additional growth. Luxco's operational capabilities and strong national sales platform are valuable and important components of this deal. The company's St. Louis, Missouri, Cleveland, Ohio and Northern Ireland bottling facilities will complement our existing capabilities and capacity, both for our existing brands as well as for our branded spirits customers. The 2 Kentucky based whiskey distilleries and joint venture Mexico tequila distillery offers significant operational capacity, which we plan to optimize throughout the integration process. Along with the addition of substantial production capabilities, we'll gain a highly experienced sales and marketing team, greatly strengthening our ability to market our existing branded products. There are many reasons to be excited by this combination, beginning with the effect that Luxco products will have on our product mix. The combined product portfolio immediately shifts our business mix toward higher value added, higher-margin products, consistent with our identified long-term strategy while also providing sustainable growth opportunities, which benefit all of our various stakeholders. The addition of Luxco's branded spirits business provides a growing portfolio of premium brands, which offer significant long-term upside as well as a core portfolio positioned at affordable price points to provide stable cash flows. It's simply a step change in MGP's branded spirits business that provides a platform with immediate scale and infrastructure, along with the added benefit of a strong foundation for future growth. Talented people are an important part of our business, and this acquisition provides the opportunity to add valuable and experienced talent necessary to facilitate integration and to keep the combined organization on the growth track we are following. As part of this deal, the seasoned Luxco leadership team will remain providing decades of experience in all aspects of the branded spirits business. We are excited to welcome Donn Lux and his wealth of industry experience to our Board of Directors following the close of this transaction. Adding Luxco's capabilities and strong existing business was truly a unique opportunity to elevate our position in the branded spirits industry, entirely consistent with the company's ongoing strategy. Also, it represents a financially attractive combination, which we believe will benefit MGP shareholders. On that note, I'll ask Brandon to provide an overview of the deal financials. Brandon?

Thanks, Dave. As Dave mentioned earlier, the acquisition reflects a total enterprise value of $475 million. Under the terms of the agreement, Luxco's shareholders will receive aggregate cash consideration of $238 million, subject to customary adjustments for working capital, net indebtedness and transaction expenses. They will also receive 5 million shares of MGP common stock valued at approximately $238 million based on a 20-day volume weighted average price as of January 11, 2021. Luxco shareholders will have the right, subject to certain conditions to nominate up to 2 of the company's 9 board directors, with Donn Lox being designated as the Luxco Shareholders First Director following the close of the transaction. The cash portion of the purchase price plus transaction-related expenses will be financed by borrowings under MGP's existing revolving credit facility. This purchase price represents a multiple of 16.9x the 12 months ended October 31, 2020, adjusted EBITDA and 13.8x the run rate synergized adjusted EBITDA for the same period. This transaction will improve our gross margin and cash flow generation profile, and we expect EPS to be low to middle single-digit percentage accretive in the first full year following its close, excluding onetime transaction expenses. Luxco's recent financial metrics for the 12 months ended October 31, 2020, which are included in the presentation deck, show adjusted annual net revenue of $202 million. Gross profit for the same period of approximately $76 million. Gross margin percentage of approximately 37% and an adjusted EBITDA margin in the mid-teens. This combination provides MGP a platform with immediate scale and infrastructure, with the added benefit of a strong foundation for future growth. Although adjusted 9 liter case volume growth has moderated in recent years, the business has experienced strong performance at the EBITDA level as mix has shifted toward higher-margin products, resulting in both growth in EBITDA and expansion in EBITDA margins. While this trend accelerated more recently due to COVID, we expect the business to perform at a more normalized rate in line with category trends going forward. We expect to realize cost and revenue synergies of $6.4 million by the third fiscal year, with the vast majority coming from cost savings. We're comfortable with our post-closing leverage at 3x the pro forma adjusted EBITDA for the trailing 12 months at closing. Additionally, we anticipate the strong free cash flow generation capabilities of the business will support deleveraging our balance sheet to approximately 2.5x pro forma adjusted EBITDA by the end of year 1. As a result, we fully expect to remain in compliance with the requirements and covenants of our credit agreement post the transaction closing, which is anticipated during the first half of 2021. Now I'll turn the call back to Dave for some closing comments.

Thanks, Brandon. We believe that combining the businesses of MGP and Luxco greatly enhances our competitive position and strengthens our ability to realize long-term sustainable growth. Our management team and our Board are excited by this opportunity to add quality scale to our business. This transaction represents a financially attractive opportunity by enhancing long-term profitability, cash flow generation and shareholder value creation. At this time, Brandon and I will be happy to take your questions regarding our Luxco transaction. Operator, please begin the question-and-answer portion of the call.

[Operator Instructions] The first question comes from Alex Fuhrman with Craig-Hallum.

And congratulations on the announcement this morning, that's certainly quite a transaction. Would love to hear a little bit more about what the spirit's portfolio is going to look like when this deal is consummated? And really what the priorities are going to be going forward. I know heading into this announcement, bourbon and rye whiskey, obviously, are -- were the lion's share of your own this distilled spirits portfolio. Can you talk about how important bourbon and rye whiskey are going to be going forward? And what other categories there might be opportunity for you.

Sure. Alex, this is Dave. Yes, obviously, with bourbon, and rye whiskeys being some of the higher growth categories and distilled spirits. That will continue to be a focus of ours. Luxco has a very strong position within bourbons and rye whiskeys. They also have a nice portfolio of tequila. So tequila, as you probably well know, it's also one of the higher growth categories within distilled spirits. So we like the addition of the whiskey brands as well as the tequila brands, the Luxco acquisition. But Luxco also has a full-scale portfolio and participate in literally all categories within distilled spirits. So we think this is a very attractive combination between our existing brands and Luxco's premium position brands as well as their legacy brands that are very good at generating cash flow.

Great. That's really helpful. And can you talk about how Luxco's production capabilities compare to yours? I think you mentioned this is going to really give you a kind of an entry in tequila manufacturing. Are there any other real production capabilities that we should be thinking about here and perhaps opportunities to combine them with MGP's existing capabilities?

Yes, absolutely. So let's go on the bottling operations side. They have bottling facilities in Cleveland, Ohio, St. Louis, Missouri and in Northern Ireland, and they can bottle all different sizes of spirits. They have blending capabilities in all of those facilities as well. Northern Ireland is a Irish cream -- has Iris cream, blending and bottling capabilities as well. On the distillery side, Luxco has 2 distilleries in Kentucky. They built a very nice distillery in Bardstown, Kentucky a few years ago, which is the primary whiskey/bourbon distilling capacity for the company. And then they also have a facility in Lebanon, Kentucky, Limestone Branch Distillery, which is a smaller scale, but more of a craft type distillery and also have a 50-50 JV on a tequila distillery in Mexico. So it adds a significant amount of capability to MGP that we historically have not had, including obviously Kentucky whiskey distilling capabilities and a full range of bottling capabilities that we think we can leverage with some of our existing customers as well.

The next question comes from Ben Klieve with National Securities Corporation.

I'll echo the previous comments. Congratulations on this. I know it's been something you guys have probably been working on for a while. So congratulations on making a big splash here. A couple of questions from me. One, wondering if you can talk about the degree to which Luxco's business is exposed to the export market and how that exposure has evolved over the past few years?

Yes. Ben, Luxco has a fairly small-scale international business today. So there hasn't been a lot of impact on the business related to the tariffs, et cetera. We do, however, think that growing internationally with this portfolio as well as MGP's existing portfolio provides an area of opportunity going forward. But currently, it's a fairly insignificant part of the overall sales of Luxco.

Got it. Got it. Perfect. And then if you look at -- I appreciate that you guys laid out kind of the revenue rate here over the past couple of years, so we can get a sense of their growth. Can you just talk about if there has been any like acquisitions maybe that have fueled that? Or the degree to which COVID has impacted their TTM business? Anything like that, that can really kind of help us get a sense of how sustainable the growth rate we've seen over the past couple of years has been?

Yes. The primary reason of the growth over the last few years has been a focus by Luxco of investing in their premium brands, i.e. the whiskey brands, the tequila brands, et cetera, to try to really increase the level of marketing support and really position and reposition the company as a branded consumer products company and letting the needs of the consumer drive how they invest behind their brands. And they've done a really nice job of that. They started about 4 to 5 years ago, making those investments, and it started to pay off here over the last couple of years, in particular. But yes, they've done a nice job of repositioning the portfolio, trying to optimize the mix within the portfolio towards the more premium positioned brands. And they've also made some pretty significant investments in their distillation capacity by building a new distillery in Kentucky that we spoke of. They've also bought a smaller scale craft distillery in Kentucky, and then they've created a joint venture on a large tequila distillery in Mexico. So they've made smart investments in the right categories both on the supply side as well as how they've repositioned their brands.

The next question comes from Mitch Pinheiro with Sturdivant & Co. Mitch, are you muted?

I was muted. Just a couple of questions. So looking at the slide with the expected run rate synergies. So $6.4 million by the third fiscal year. And that's -- is that a combination I'm assuming of -- is that -- I'm not sure what that is, is that the cost synergies? Or is that revenue -- revenue synergies is on the same slide. Can you talk about that a little bit?

Yes.

Where that that's being -- what is comprised of?

Yes, you bet. Great question. So yes. The slide, Mitch, I think you're referring to is on Slide 15 of the presentation for everybody else. So what we say there is $6.4 million in synergies by the third fiscal year. And what that $6.4 million is composed of is both revenue and cost synergies. So for revenue synergies, it means taking MGP brands to national distribution as well as incremental sales are relating to source -- our sourced alcohol business with the added capabilities. However, the vast majority, Mitch, of that $6.4 million is from cost savings. So we expect to get that through back office and warehouse savings, bottling, dry goods, procurement savings as well as duplicative services in functional areas like that. So the main takeaway is it's going to be a ramp-up to get to that $6.4 million, but we do have it in sight, and the vast majority is going to come from the cost side, not the revenue side.

So why wouldn't we expect a little more revenue synergy by the third fiscal year. You have terrific brands that you own and what would be the -- it just seems to me a more -- a slower-than-expected revenue synergy ramp by the third year?

Yes. I think, Mitch, the -- what we're trying to do here is be relatively conservative in our synergies at this point. I think as we get the transaction closed and we really start working with the organization and understanding the broader opportunities with the customer set. We're hopeful that we can grow the revenue synergies more significantly. But obviously, starting out, we're taking a fairly conservative position here.

Okay. If you could talk about -- I know it's not your decision to sum, but if you could talk about the motivation behind Luxco's decision to sell?

Yes. I mean, that's really not something that we can speak for Luxco on their behalf. But we're both excited about combining these 2 companies. We think that will be better together versus a part. And both Luxco and MGP are extremely excited about the combination of the 2 companies and look forward to long-term sustainable growth going forward.

And then what -- just looking at the volume at Luxco was up modestly over the last couple of years. Is that a function of premium growing and the value end, not so much? Is there -- is that the -- you have to cause?

Yes. Luxco, that's -- the short answer is yes, Mitch. There -- as we discussed in the prepared remarks, Luxco's done a very nice job of repositioning the portfolio to try to optimize the overall profitability of the company. And there, Luxco has a little over 100 brands. So they participate in all categories and at all price points, kind of across the spectrum. So as you can imagine, with the more premium position brands, those are growing at higher rates and the more value-oriented brands are stable to somewhat declining depending upon what categories they're in. So the combination of those factors is what you're seeing play out on the top line.

And then one more question. Can you just talk a little more about the tequila JV? What -- who is that with? And how -- any structural details that would be helpful.

Yes. It's a -- the Luxco's had a long-standing relationship with a family in Mexico going back 40, 50 years. And they've historically been a supplier of tequila to Luxco, and the 2 companies decided in order to basically increase the sustainability and certainty of supply around tequila to form a JV. It's a 50-50 JD -- or JV, excuse me. And it's not only on the distillery side, but also there's a beginning -- they've also formed a JV to grow agave as well. And again, that's for certainty of supply around agave itself to feed into the distillery.

The next question comes from Donald McLee with Berenberg.

Can you hear me?

Yes, it's good.

Perfect. So just curious on how we should think about this transaction. And the expected free cash flow benefit in regards to you guys capital allocation and historical dividend growth? Is it a situation where dividend growth is unlikely as you work through the incremental debt? Or could we potentially see some upside prior to that? I know in the slide, you said that you plan to maintain the current dividend, but I'd imagine over the intermediate or longer term, that there's definitely going to be a benefit -- there should potentially be a benefit. So what are your thoughts there?

Yes, Donald, this is Brad. Great question. And we'll start with the dividend because that's where you left it. And that's exactly right. We do plan on maintaining the dividend at these levels. Our focus immediately going forward is going to be delevering somewhat and keeping our opportunities accessible to MGP and our shareholders. But it does not mean to your point that it's going to be that way over the long term. So dividends are something that we reassess every quarter with our Board, and we factor in all types of considerations into that decision, and we'll continue to do that going forward. As far as capital allocation priorities going forward, it's still going to be pretty consistent. This is obviously a large transaction for however, we're confident that we've done it in a way that was prudent in that -- the components of the deal being cash and equity we're done in a way to not put too much stress on our balance sheet, which will keep us nimble going forward. But at the same time, it's inviting the Lux family into our shareholder base and on to our Board, which we believe we're going to benefit from for a lot of years to come. So acquisitions will still be something that we're going to be looking at, but probably more near term, from a capital allocation standpoint, we're really going to be focused on integrating this business and maximizing the value.

Got it. And then just one more on Luxco, but could you talk a bit about the channel mix there between off and on premise? I'm just trying to get a -- to the earlier question about what was the motivation for Luxco? Just trying to get a feel for maybe how they performed last year based on that channel mix?

Yes. Their channel mix is pretty consistent with the industry, about 80% off-premise and 20% on. And they've actually performed very well through COVID parts of their portfolio, the whiskey brands, et cetera, have shown really strong demand throughout the COVID environment. So they're pretty consistent on a channel mix perspective with what you'd expect to see in the broader spirits industry in the U.S.

The next question comes from Bill Chappell with Truist Securities.

Just a series of questions, so bear with me. I guess, first, on the portfolio, is there a way to -- can you break out like what percentage is brown versus white what percentage is maybe premium versus value? And then what percent you are already supplying from MGP versus what they were making themselves or outsourcing elsewhere?

Yes, Bill, this is Brandon. Thanks for the question. So we're still internally finalizing how we're going to break this out going forward and expect more as we go on that front. But there is a slide within the presentation that's on our website, where it does speak to with regard to as the focus brands. So those are the more premium, super premium type brands. There's about a dozen or so that are listed there in the Luxco portfolio. And those represent about 46% of total revenue. So that should give you a pretty reasonable starting point there. As it comes to how much are we supplying, we do supply a good amount of GNS to Luxco and has historically not all of their needs by any stretch, but we have been a supplier in the past. And then we've additionally supplied whiskey, both bourbon and rye in the past as well. But just in small amounts in recent years as they've added their own production capacity in Kentucky that we've discussed.

So you're not -- I mean, it's not a majority of their revenue is your supplying. You're saying it's much smaller.

Absolutely, yes. Yes.

And then in terms of -- again, on the brand, I'm not as familiar with all of them. Probably, unfortunately, I'm most familiar with Everclear for my college days, but just trying to understand, is it -- the whiskey is more premium brands and the white spirits are where you're more value? Is that the best way to look at it?

It's a combination, Bill. I think definitely the whiskey brands are positioned more towards the premium, super premium, categories. However, Luxco does have some, what I would call emerging brands, even in the white goods space, primarily in, I guess, I wouldn't consider maybe don't consider tequila white goods, but they do have some nicely positioned premium and super premium tequila brands that are doing nicely, and we expect to continue to grow and then they do have some value in mid-tier white goods in the vodka category as an example. But this is a very diverse portfolio that's represented in literally every category within distilled spirits, including -- they've got a nice Irish cream brand and a couple of actual Irish cream brands that are doing well. But yes, it's a diverse portfolio. I don't know that it's really overweighted in any one particular spirit type, if you will. It's a fairly smooth blend, if you will, across the different categories.

Got it. And so I guess I'm also trying to understand both on the top line in saying that sales growth had moderated. Is that more because of your exposure to some of the white spirits, whereas brown spirit has grown faster? And then on the margin front, it seems -- I guess, it seems like for a branded spirits company, the margins were a little bit lower than I would have expected. So is there room for improvement? Or is that just kind of the nature of what you sell?

Yes, Bill, great question. Thanks for clarifying that. So in Slide 10 of the presentation, there's a chart there. And when we said that sales were moderating, what we meant there, Bill, was that volume shipments. So 9 liter case sales were moderating. Actual revenue as you can see there, on adjusted basis, has grown quite nicely over the last 3 years through the LTM October 2020 period. And you are seeing, as you note, expanding margins as a result. So we're seeing increasing revenue, increasing gross profit and EBITDA, but arguably, more importantly, the margins are also expanding quite nicely.

Got it. Maybe, I guess, for the nature of business, I mean, this is a bad example, but Brown-Forman has 70% gross margins. So this is more like 30%. So is that more just because there is more white spirits involved?

Yes, that's right. So yes, just to add to that. Margins are not where they were even a couple of years ago. As I already said, they've actually improved quite nicely. We also expect that to continue in the future. So said another way, they've been investing, as Dave mentioned, quite heavily to reposition their portfolio towards the higher margin on trend focused brands that we've discussed. So we definitely do view that there's still room for margin improvement as we focus not only on the portfolio mix, but also on cost structure efficiencies. We expect that gain as time goes on.

Got you. Last 2 for me. So I assume you were keeping all of the marketing and back office and sales team for them because -- and then that will be, I guess, located in St. Louis? Is that the right way to say it? And then also Bran, just a quick -- do you have a rough D&A number because it's a little bit tougher to go from EBITDA to your accretion number without some kind of D&A, I understand.

Yes on the -- we will post close, retain the Luxco senior leadership team and the entire organization for the -- essentially, obviously, this is -- it will become our branded spirits segment, if you will, within the company. And a big part of what we're acquiring here in addition to the, obviously, the portfolio of brands is the talent of the organization and the fact that it has national distribution as well as international sales capability and coverage. So it will be based and continue to be based in St. Louis. And we think that's another key advantage of buying a company like Luxco.

Yes. When it comes to the earnings per share, Bill, and the D&A. There are some slides toward the back. I won't drag everybody through it right now, but that do show not only Luxco's but also MGP's D&A. So you can get that as a reference. And then yes, as stated earlier on the call, we do expect EPS to be low to middle single-digit percentage accretive in the first year following close, excluding the onetime transaction costs, as we mentioned.

And you remind me, one last one. You don't have actual EPS guidance for 2020 or 2021. So should -- and there was no other announcement, should we assume that everything was on plan for 2020? And as they can be accretive, what the number you're accretive off of kind of is important.

Yes. Understood. And we'll address Q4 and also guidance on the Q4 call as we get closer to that.

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

We'd like to thank all of you for participating in today's call and your continued interest in MGP. Thank you.

This concludes -- the conference has now concluded. Thank you for attending today's presentation.