Good day, and welcome to the Second Quarter 2020 Results Conference Call. 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 with Lambert & Co. Please go ahead.

Thank you, Ian. Good morning, everyone, and thank you for joining the MGP Ingredients' conference call and webcast to discuss the company's financial results for the second quarter 2020. I'm Mike Houston with Lambert & 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 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. If anyone does not already have a copy of the press release issued 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, Dave Colo. Dave?

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. Turning to the results for the second quarter. We remain encouraged by the demand for our products, the improved financial results as well as a strong balance sheet with ample liquidity to weather the challenges and uncertainty related to the COVID-19 pandemic. We saw improved results across most parts of our business this quarter, including the solid sales growth of aged whiskey, stronger sales for our white beverage and industrial alcohol products as well as solid gains in both revenue and gross profit for our Ingredient Solutions segment. Both of our business segments showed top line growth over the prior year, and as a result, our consolidated sales for the quarter increased more than 2%. On a separate note this quarter, MGP was the target of a cyber-attack that temporarily disrupted production at our assets and facilities. We have since resumed normal operations. And while there was no evidence that any sensitive or confidential data breach occurred, we take this issue and the integrity of our data and our systems very seriously and have since implemented a variety of measures to further enhance our cybersecurity protections and minimize the impact of any future attack. We estimate that the ransomware attack had a negative impact to gross profit of approximately $1.7 million, primarily as a result of a business interruption. The majority of the negative gross profit impact affected our Ingredient Solutions business segment during the quarter. We have insurance related to this event and are seeking to recover a portion, if not all, of any profit…

Thanks, Dave. For the quarter, consolidated sales increased 2.3% to $92.6 million, reflecting growth in both the Distillery Products and Ingredient Solutions segments. Consolidated gross profit increased 6% to $20.7 million as a result of increased gross profit in the Ingredient Solutions segment, partially offset by a $1.7 million impact of the cyber-attack that temporarily disrupted production at the Atchison facilities. Consolidated gross margin increased approximately 80 basis points to 22.4% of sales, up from 21.6% in the prior year quarter. Corporate selling, general and administrative expenses for the quarter were $9.4 million, up 8.3% versus prior year, due to higher personnel and incentive compensation costs, inclusive of certain incremental costs incurred related to the transition at the CEO position. We are focused on effectively managing SG&A, while still investing to grow. Consolidated operating income increased 4.3% to $11.3 million compared to $10.9 million during the prior year quarter, reflecting the increased gross profit in Ingredient Solutions segment, partially offset by decreased gross profit in the Distillery Products segment. Further offsetting the increase in operating income were the impacts from the aforementioned cyber-attack and increased corporate selling, general and administrative expenses. Non-GAAP operating income increased 11.5% to $12.1 million, exclusive of CEO transition costs. Our corporate effective tax rate was 23.1% in the current quarter compared to an effective tax rate of 25% in the prior year quarter. Net income for the second quarter increased 7.3% to $8.5 million, and earnings per share increased $0.04 per share to $0.50. Non-GAAP EPS increased to $0.54 per share from $0.46 per share in the second quarter of 2019. These increases from prior year are primarily due to improved operating results. We discussed the strong fundamental cash-generating capability of our business, which allows us to provide positive operating cash flows even as we…

Thanks, Brandon. Now, I would like to touch on some additional initiatives that support our long-term strategic plan. The headwinds we identified last quarter have persisted with varying impacts on our financial results. During the quarter, the first headwind related to the initial pantry loading that had occurred during the first several weeks of the pandemic, which caused off-premise sales to significantly spike. While these elevated growth comparisons began to taper in the back half of the second quarter, the demand for distilled spirits, including American Whiskey, remain strong. We are unsure how long these purchasing behaviors will continue and what potential impact they might have on future off-premise sales. We believe the spike in off-premise sales during the pandemic have partially offset declines in on-premise sales across the nation. As more bars, restaurants and tasting rooms reopen, we expect the off-premise sales to normalize overtime. As you would imagine, the closures of bars, restaurants and tasting rooms had an immediate impact on our craft customer sales the past few months, even though, some states implemented phased reopening plans. We would anticipate these trends to improve as these establishments reopen, but it is difficult to predict when that might occur in a meaningful way. Third, we began to see some of our multinational customers conserve cash this quarter, which had an impact on new distillate sales results. While most have strong balance sheets and access to capital, it is unclear how the conservation of cash may introduce additional quarterly sales volatility, which could impact our brown goods sales throughout the balance of the year. Lastly, international export sales did not meet pre-pandemic expectations as travel has been dramatically reduced and tariffs in key international markets persist. We continue to believe that our investments to expand international sales will provide long-term…

[Operator Instructions] Our first question comes from Donald McLee of Berenberg.

So just to kick things off, I wonder if you could talk a bit about some of the product characteristics that differentiate the specialty ingredients products from the commodity products. And what markets they ultimately serve?

Yes, sure. So let's start with the markets. I mean we sell primarily into baked goods, pasta and snacking categories. As far as the product lines there, let's start with specialty starch and particularly Fibersym. It basically allows for formulators to introduce fiber, and as a result, result in a net carb on the finished product. It also -- because it's a wheat-based fiber, it blends extremely well with other wheat-based proteins such as Arise. So you're getting the benefits of a high-fiber and high-protein combination, which results in lower net carbs. So both of those product lines are on trend as consumers continue to try to find ways to increase protein, increase fiber and reduce carbs. So those are the primary drivers of what's driving the increased demand we see in those two particular product lines.

Okay, that's really helpful. And then switching to your CapEx guidance. So first question, could you talk a bit about the pacing of that $20 million or so of CapEx in the back half of the year? And then as a follow-up, how much of that CapEx is maintenance versus expansion?

Yes. Welcome to the call, Donald. This is Brandon. I'll take that one. So we are still guiding full year CapEx to be $19.6 million. So year-to-date, that number is coming in right around at $6 million. So you can expect the lion's share of that $19.6 million to come in the back half. Our projects do range between maintenance and growth as well as environmental-type projects and safety. So beyond that, we don't give further breakdown in detail as to how much in each bucket, but just know that we are always looking for ways to invest capital to better position our company within the industries we serve.

Okay. And then, just the last one for me. Could you talk a bit -- or can you provide some color on how -- the U.S. spirits market share, how that's trended year-to-date within the overall beverage alcohol category amid the disruption of COVID-19?

Yes. I think that what the trends have been playing out during COVID is the off-premise sales have been up significantly versus prior year. Early in the pandemic, let's call it, the first two months, spirits, in particular, were trending up 30-plus percent in the last few weeks as some partial reopenings have occurred in on-premise. Off-premise spirit sales are continuing to be up about 20%. So overall, with on-premise being off substantially, off-premise up, it's almost a net position for growth in the overall spirits category year-to-date.

Our next question comes from Bill Chappell of SunTrust.

The rapid fire, just kind of going around on a few issues. I guess, one, on the new distillate sales in the quarter that were hit by customer shutdowns or just delays, have you seen any of that come back? Has it got any worse as you went through the quarter? Have you had any indications from the customers as to whether they will come back?

Yes, Bill, I think what we -- two things we saw kind of impacting that in the quarter was, one, cash conservation by customers. And I think that's driven just by the uncertainty of the situation we're in with COVID. So that was definitely a significant contributor. And then the other thing I would say is, again, just some customers working off some inventory during the quarter. As far as what we would expect going forward, I do think that as long as COVID is around, it's going to continue to put people in a position where they're going to be conservative with their cash. And then if demand stays relatively flat in the market, with the on-premise offsetting the off-premise gains, I would anticipate it's going to take them a while to work through inventories as well. But long-term, I think we still feel very good about new distillate sales.

Is there any way to quantify what the impact was in the quarter for that?

Yes. We did share, Bill, that the new distillate sales volumes were down, whereas, aged, on the other side, was in very strong double-digit growth territory from a percentage basis. Another thing that I think worth highlighting on that is that although total brown sales were off 7.5%, total gross profit and gross margins were up for total brown. So this quarter, I think, it's a really nice example of the fact that even our diversification within the brown's product category -- total brown product category is really lending a hand to our ability to meet our customer needs in a shifting environment like what we're seeing now.

Got it. And then switching over to the aged side. That's great that things are continuing to be in a positive momentum there. But I guess, Dave, on your comment that you want to meaningfully get down the aged inventory on the balance sheet, which is probably, I guess, about $113 million. That would imply you have a home or a potential home for some of this inventory in the back half of the year. Otherwise, I guess, it would just continue and hopefully at reasonable prices. So can you may be talk about that? And what your visibility is into getting the inventory level down?

Yes. I think as we spoke about this, I think, at the inventory levels we're at now, we feel pretty good that we've got adequate vintages, if you will, and different mash bills to support the demand that we see in the near term for both our customers as well as our own internal use. So I think it will be a combination of the demand for the product that will bring the inventory levels down as well as our put-away scaling that back a bit. So those two factors, I think, will contribute to the decline in the overall value of our aged whiskey.

So, is it safe to say that you feel comfortable that you can place it in the back half despite customers being a little tighter with their cash?

Yes. I think we saw a pretty good demand here in Q2. And as far as what we're seeing going forward, I'd say with the craft distillers, we did see softness in Q2. As some of the partial reopening start to occur, that has a positive benefit on the craft players. So we're hopeful that we'll see some improvement in demand with craft and then ongoing demand with the national and multinational customers. And then, of course, as things open up internationally, we would hope that our export sales opportunities come to light as well.

Got it. And then, switching to industrial alcohol; I mean, I know things have contracted out, you're running at 100% utilization, but volumes seem to pick up sequentially, implying that you found a little more capacity. Is that a good number to kind of use for the remainder of the year in terms of extra volume? Or can you find even more from here?

Yes. I mean the way what we're trying to do there, Bill, is basically meet the contractual volume obligations that we have with key customers as well as -- I think we spoke about this on the last call, those long-term customers also came in for some incremental demand. So we're also trying to make sure we can support the incremental demand as much as possible. We're fully booked for the balance of the year, and we're just trying to meet those contractual commitments for the balance of the year.

But it sounds like you're finding some excess capacity. Is that fair?

Yes, yes. I think it's -- basically, the distilleries are running very, very well, very efficient. And we've been able to pick up some capacity as a result of that.

And do you still think you can get some pricing potential as we move into 2021, if demand remains as strong?

Yes. I think that's definitely the pattern that we're seeing. We anticipate that, obviously, the demand is staying strong for the balance of this year. Based on what we know now, we think that the demand will stay elevated as we go into 2021. And we are seeing prices reflect that as we're coming into the new contracting season here in the back half of the year.

Great. And then, last one for me on Ingredient Solutions. Just you talked about focusing more on the higher profit. Is it -- type items -- is it safe to say that, that, I guess, profits for this division will grow faster than sales, at least, for the next few quarters?

Yes. I think the team has done a really good job on selling the specialty wheat proteins and starches and minimizing the commodity products. So that if that trend continues, then your statement is fairly accurate that, that should be what kind of plays out here in the back half.

And our next question comes from Alex Fuhrman of Craig-Hallum Capital Group.

I wanted to follow-up on the plan to reduce your aged inventory levels. I mean, obviously, it was never the plan to grow those forever. But it sounds like just from your commentary on the call that maybe there's a little bit of extra motivation to reduce those levels than we've seen earlier in the year. So can you talk about maybe some of the trends you're seeing about the category, perhaps starting to normalize that have caused you to reach the determination that you want to start to be reducing your aged inventory levels? And then, just bigger picture. I imagine you still want to be having a portfolio of aged whiskey as part of your library and your business. Is there a certain kind of dollar level we should be thinking about that as kind of a minimum level that you need to have in order to be a significant player in that space and have a good assortment of mash bills and vintages?

Yes, yes. Great questions. As far as the why do we feel like we can start scaling back, if you will, the amount of aged inventory? I think, as we spoke in the prepared remarks that the -- as we were putting away products five to six years ago and even over the last few years, the category growth in the -- particularly in the customers that we were building this inventory for were growing mid-double digits, we see the trends kind of slowing down a bit and becoming more in line with the overall category growth. So that's -- I would say that's the primary reason why we're scaling back. We will always -- at least, at this point in time, we will always put away whiskey each year to make sure that we've got the proper vintages as well as the proper mash bills to meet our customers' needs going forward. But given the fact that we have put away a lot of whiskey, we're just basically kind of normalizing those inventory levels based on what we know today going forward. As far as what's the sweet spot with that number and the amount of inventory, that's a -- honestly, it's something that we evaluate quarter-to-quarter. It's going to be a dynamic number. If we see growth projections increasing, then we'll probably put away more. If we see growth projections decreasing, we'll probably put away less, that type of thing. So I don't think there's a hard and fast number, Alex. I think it's going to be dynamic, and we'll adjust it based on what we see going on in the market.

Okay, that makes sense. And then if I could also just ask on the cyber-attack. I think you mentioned the impact to gross profit on the quarter was $1.7 million. Can you just walk us through the specifics of that number? I mean, is that lost sales? Is that increased production cost or having to move inventory around? And should we expect that to kind of come back in the back half of the year? Just any color on how we could think about that from a modeling perspective? That would be helpful.

Yes. Good question, Alex. This is Brandon. So as Dave mentioned on the call already, the majority of that $1.7 million impacted the Ingredient Solutions business. And you hit it right on the head. It was largely, if not entirely, attributable to business interruption, including reduced sales as well. So we are in the process, we are insured in this type of event and we -- we're trying to get some, if not all, of that $1.7 million reimbursed back to the company. And we're very hopeful that it will be by the end of the year and potentially even within the third quarter.

[Operator Instructions] Our next question comes from Ben Klieve of National Securities Corp.

First, just a couple of follow-on questions regarding the cyber-attack. First, sorry to hear about that. How long was production shutdown as a result of that?

Yes. We didn't share that. It wasn't up to cause disruption to our business and affect customer orders. As you can -- as is implied by the $1.7 million gap that we identified. However, we are up and running. We have made a lot of positive adjustments as we go forward from a remediation standpoint. And as -- and we ended the quarter in great shape unaffected by the impact.

Okay. And I think you might have just answered my next question. But the -- so it sounds like as of July 1, the impact of that was in the past, and so third quarter should be -- should not be impacted as a result of that, is that correct?

That's exactly right.

Okay, perfect. And then, just one other question for me here. As you look at the potential for M&A, Dave, now that you've been here for, I guess, nearly a full quarter now at this point. Given everything that's going on in the world and especially, with -- especially impacting the food service industry, how are you looking at M&A in the branded spirit market? And how has that -- your thought process here evolved over the past three or four months? And what -- kind of how -- what are your expectations on the M&A front over the next few quarters?

Yes. We still view branded spirit as a great space, long-term. There is some choppiness in the short-term, obviously, in just about every food and beverage category due to the pandemic. But I think the way we look at M&A is much more long-term and what do we think the long-term trends are going to be, and that's what gives us confidence that as we evaluate M&A, and particularly M&A in branded spirits, we do think that's an excellent category to participate in over the longer term. So it doesn't really deter us, per se, based on the current conditions. And so we continue to actively look at potential opportunities and feel it will be a great addition overall to the company if we can be successful.

This concludes our question-and-answer session. At this time, I would like to turn the conference back over to David Colo for any closing remarks. Please go ahead.

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

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