MGP Ingredients, Inc. — 2016 Form 10-K
Business context and reporting period. This annual report covers the fiscal year ended December 31, 2016; it is not a quarterly filing. MGP produces distilled spirits and alcohol products, and specialty wheat starches and proteins, through its distillery products and ingredient solutions segments. Unless otherwise noted, financial amounts below are in millions of dollars.
Financial performance and liquidity
| Metric | 2016 | 2015 | Change |
|---|---|---|---|
| Net sales | $318.3 | $327.6 | (2.9%) |
| Gross profit / margin | $65.3 / 20.5% | $58.5 / 17.9% | +11.5%; +2.6 percentage points |
| Operating income / margin | $42.0 / 13.2% | $32.9 / 10.0% | +27.8% |
| Equity-method investment earnings | $4.0 | $6.1 | (33.9%) |
| Net income | $31.2 | $26.2 | +19.1% |
| EPS | $1.82 | $1.48 | +23.0% |
| Operating cash flow | $19.7 | $18.7 | +$1.1 |
Segment results. Distillery products sales were $265.2 million, down 1.8%, while gross profit rose 12.2% to $56.8 million and gross margin increased to 21.4% from 18.7%. Premium beverage alcohol sales grew 14.5% to $150.4 million, while industrial alcohol sales fell 21.9% to $77.3 million. Ingredient solutions sales declined 7.6% to $53.0 million; gross profit increased 7.3% to $8.4 million and gross margin improved to 15.9% from 13.7%.
Fourth quarter. Q4 2016 net sales were $81.1 million, versus $81.5 million in Q4 2015. Operating income was $10.6 million versus $10.1 million; net income was $8.3 million versus $6.5 million; EPS was $0.48 versus $0.38. The filing reports a $3.385 million legal-settlement and asset-sale gain in Q3, not Q4.
Cash, debt, and liquidity. Cash was $1.6 million at year-end. Current assets were $110.9 million and current liabilities $37.0 million, a $73.9 million excess; inventory was $78.9 million, including $50.9 million of barreled whiskey. Total debt was $36.0 million, and $51.6 million remained available under the credit agreement. Net cash used in investing was $17.7 million, including $17.9 million of property and equipment additions; financing used $1.2 million. The company reported compliance with credit agreement covenants at year-end.
Material changes and notable items
- Sales declined, but gross profit and operating income improved, principally from a richer product mix, lower input costs, and improved plant efficiencies. Ingredient sales faced lower prices and volumes.
- Net income benefited from $3.385 million of other operating income related to a legal settlement and gain on asset sales, as well as tax benefits from early adoption of share-based compensation accounting. The 2016 effective tax rate was 30.3%, compared with 31.8% in 2015.
- Inventory increased $20.1 million; barreled whiskey inventory increased $22.7 million as MGP built stocks for future wholesale sales, partnerships, and its brands.
- MGP acquired the George Remus brand in November for $1.551 million cash, plus $0.350 million estimated contingent consideration. It also introduced Till American Wheat Vodka and expanded its distribution.
- ICP, in which MGP holds a 30% interest, contributed $4.0 million of equity earnings, down from $6.1 million. MGP received a $3.3 million ICP distribution in 2016; future distributions are not assured.
Outlook, risks, and contingencies
Management provided no specific earnings or revenue guidance. It expects approximately $22 million of 2017 capital expenditures and anticipates completing the approved $29 million Lawrenceburg warehouse expansion program by the end of 2018. The company expects cash from operations and its credit facility to support operating needs and budgeted spending. It stated it expects to continue quarterly dividends, subject to future earnings, capital needs, and debt service.
- Regulatory matters: EPA issued a Notice of Violation alleging construction of Lawrenceburg whiskey warehouses without a Clean Air Act permit. MGP considers a penalty probable, but could not estimate the amount; it did not expect the matter to materially affect results. A separate October 2016 chemical release at Atchison is under investigation. MGP believes regulatory penalties may be imposed and private claims may arise, but could not estimate potential losses.
- Ingredient exposure: MGP’s Fibersym resistant-starch patent rights expire in 2017. It has petitioned the FDA regarding dietary-fiber classification of Fibersym RW and FiberRite RW; the filing warns that delayed confirmation under new labeling rules could adversely affect ingredient results.
- Operating and market risks: Results are exposed to grain, wheat flour, energy, ethanol and co-product pricing; limited raw-material suppliers; competition and customer demand; aging-whiskey inventory decisions; and reliance on ICP for some industrial alcohol sourcing. Brand acceptance, distributor performance, water availability, facility disruptions, product liability, regulation, and cybersecurity are also identified risks.
- Other exposures: Contractual obligations totaled $96.5 million, including $80.3 million of purchase commitments, mostly due within one year. The company also disclosed operating lease and post-employment benefit obligations. Its credit facility is variable-rate; a 100-basis-point rate increase was estimated to raise annualized interest expense by $0.412 million based on year-end borrowings.
Important facts for investors to verify
- Whether premium beverage alcohol growth and improved segment margins can persist while industrial alcohol and ingredient solutions sales remain pressured.
- How much of 2016 earnings growth is repeatable, given the legal/asset-sale gain, tax-accounting benefit, and lower ICP earnings.
- Whiskey inventory aging, future demand and cash conversion, alongside the funding and completion of warehouse expansion.
- Developments, potential penalties, claims, and insurance coverage related to the EPA warehouse notice and the Atchison chemical release.
- FDA treatment of the resistant-starch products and the effect of the Fibersym patent expiration.
- Credit availability, covenant headroom, capital spending, and dividend capacity as debt and investment needs evolve.
- Governance and voting rights: preferred shareholders elect five of nine directors, and common shareholders have limited voting rights on certain major transactions.
KPMG issued an unqualified opinion on the financial statements and concluded internal control over financial reporting was effective as of December 31, 2016.