MGP Ingredients, Inc. — Q2 2018 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2018; comparisons are with the corresponding 2017 periods unless stated otherwise. Amounts are in thousands of dollars, except per-share data.
Business context and financial performance
MGP produces distilled spirits and industrial alcohol, along with specialty wheat protein and starch ingredients. It reports two segments: Distillery Products and Ingredient Solutions.
| Metric | Q2 2018 | Q2 2017 | Six months 2018 | Six months 2017 |
|---|---|---|---|---|
| Net sales | $88,252 | $85,753 | $176,208 | $172,922 |
| Gross profit / margin | $19,441 / 22.0% | $18,825 / 22.0% | $38,392 / 21.8% | $37,866 / 21.9% |
| Operating income / margin | $11,132 / 12.6% | $10,514 / 12.3% | $21,521 / 12.2% | $21,906 / 12.7% |
| Net income | $7,527 | $6,369 | $16,454 | $15,047 |
| Diluted EPS | $0.44 | $0.37 | $0.96 | $0.87 |
Q2 sales increased 2.9% and net income 18.2%. For the first half, sales rose 1.9% and net income 9.4%, while operating income declined 1.8%. The six-month improvement in net income and EPS benefited from lower taxes, lower interest expense, and the absence of the prior-year equity-method investment loss; operating results were a partial offset. The company sold its ICP investment in July 2017.
Segments and material changes
- Distillery Products: Q2 sales increased 2.8% to $72,652 and gross profit rose 4.6% to $16,680. Higher co-product and warehouse-services sales more than offset slightly lower food-grade alcohol sales. First-half sales rose 1.6% to $147,029, but gross profit was essentially flat at $32,550; premium beverage alcohol sales declined 1.9% year to date, partly attributed to customer-order timing.
- Ingredient Solutions: Q2 sales increased 3.6% to $15,600, but gross profit fell 3.9% to $2,761 and margin declined to 17.7% from 19.1%, primarily due to higher input costs. First-half sales rose 3.2% to $29,179 and gross profit increased 10.3% to $5,842, reflecting a shift toward higher-margin specialty products and higher average selling prices, partly offset by input costs.
- Q2 SG&A was flat at $8,309. First-half SG&A increased 5.7% to $16,871, mainly from brand-platform investment, advertising and personnel costs.
Cash flow, debt and liquidity
- First-half operating cash flow was $1,243, down from $10,843. The filing attributes the decline chiefly to increased inventory investment, lower operating cash generation before working-capital changes, and reduced accounts payable and accrued expenses.
- Capital spending cash outflow was $13,065, versus $9,933 in the prior-year period. Management expected approximately $30,000 of 2018 capital expenditures.
- Cash was $2,280 at June 30, 2018, versus $3,084 at year-end 2017. Total debt, net of unamortized loan fees, was $40,461, compared with $24,554 at year-end. Revolver borrowings were $19,324; $130,676 remained available under the $150,000 facility.
- Current assets exceeded current liabilities by $117,212, but included $106,487 of inventory, including $73,043 of barreled distillate. The company said it was in compliance with debt covenants and expected available cash sources and credit to meet operating and investment needs.
- First-half dividends and equivalents paid were $2,750, or $0.16 per share/unit. A subsequent quarterly dividend of $0.08 was declared for payment August 31, 2018.
Outlook, risks and unusual items
- Management cited growth in American whiskey demand and planned continued investment in aged-whiskey inventory and capacity. The warehouse expansion was increased from $33,800 to approximately $51,800; about $32,000 had been incurred by June 30, with completion targeted by year-end 2020.
- The filing provides no earnings or revenue forecast. Management stated it expected liquidity sources to support budgeted capital expenditures and anticipated operating needs for the foreseeable future.
- Commodity input prices and interest rates are key exposures. A 100-basis-point rise in variable rates was estimated to increase annual interest expense by $157, based on June 30 borrowings. Grain, flour and natural-gas supply contracts generally cover one to 24 months at negotiated prices.
- The 2016 chemical release at the Atchison facility remains subject to regulatory and private claims. OSHA’s settled penalty was $75. The EPA proposed civil penalties of approximately $250; negotiations were paused pending its criminal investigation. The company had not accrued the EPA amount, stating it expected a negotiated resolution and considered the proposed penalties immaterial. Potential private damages were not estimable; insurance coverage is subject to a $250 deductible, and coverage/timing is uncertain.
- The Tax Act accounting remained incomplete as of June 30, 2018. Topic 606 was adopted January 1, 2018 with no reported financial-statement impact. Management reported effective disclosure controls and no material changes in internal control beyond revenue-recognition process changes.
Important facts for investors to verify
- Whether inventory growth and whiskey-aging investment convert into future sales and operating cash flow, given the sharp year-over-year decline in first-half operating cash flow.
- Progress, total cost and returns on the expanded warehouse project and the approximately $30,000 2018 capital-spending plan.
- Segment margins, especially the recovery of Ingredient Solutions’ Q2 margin and Distillery Products’ year-to-date margin.
- Resolution and potential financial exposure from the EPA investigation and private claims related to the Atchison release, including insurance recovery.
- Tax Act measurement-period updates, effective tax rate, debt levels, and continued covenant compliance.