MGP Ingredients, Inc. — Q2 2015 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2015. Dollar amounts below are in thousands unless noted. The company produces distillery products, including food-grade alcohol, and specialty and commodity starches and proteins.
Financial performance
| Metric | Q2 2015 | Q2 2014 | Six months 2015 | Six months 2014 |
|---|---|---|---|---|
| Net sales | $85,354 | $80,567 | $165,767 | $159,563 |
| Gross profit | $17,528 | $8,308 | $30,916 | $15,109 |
| Gross margin | 20.5% | 10.3% | 18.7% | 9.5% |
| Operating income | $9,503 | $3,072 | $16,411 | $4,801 |
| Net income | $7,871 | $5,099 | $12,941 | $9,884 |
| Diluted EPS | $0.44 | $0.28 | $0.72 | $0.55 |
| Operating cash flow | — | — | $9,103 | $2,877 |
| Capital expenditures, cash basis | — | — | $8,080 | $3,594 |
Q2 net sales rose 5.9%; six-month sales rose 3.9%. Profitability improved substantially as higher volumes and a richer product mix combined with lower corn, flour, and natural-gas costs and production efficiencies. Q2 SG&A increased $2,859 to $8,025, including higher incentive compensation and CFO-related severance. Six-month SG&A increased $4,267 to $14,505.
At June 30, cash was $4,361; working capital was $57,730; and stockholders’ equity was $117,001. Long-term debt and current maturities totaled $9,567, with an additional $14 outstanding on the revolver. Credit-facility borrowings were $6,768, at a 2.44% average rate, and $51,479 remained available. The $80 million facility matures February 27, 2020; the company reported covenant compliance.
Changes and business drivers
- Distillery-products sales rose 5.4% in Q2 and 3.4% year to date. Food-grade alcohol growth and a shift toward premium spirits lifted pricing; fuel-grade alcohol and distillers’ feed/co-products declined. Segment gross margin reached 19.8% in Q2 versus 9.7%.
- Ingredient-solutions sales rose 8.1% in Q2 and 5.9% year to date, led by specialty wheat starches and proteins. Segment Q2 gross margin improved to 23.7% from 12.8%.
- Q2 equity-method earnings increased to $3,096 from $2,331, including MGP’s $1,230 share of ICP’s business-interruption insurance proceeds. Six-month equity-method earnings fell to $4,448 from $5,666, reflecting weaker ICP sales volume and pricing, partly offset by those proceeds.
- The effective tax rate was 36.9% in Q2 2015 and 37.2% for the first half, versus 1.7% in both prior-year comparisons. Prior-year rates benefited from use of deferred tax assets, so the comparison materially affects net-income growth.
- Inventory increased to $45,017 from $34,441 at year-end, principally due to safety stock and additional barreled distillate held for aging; this was a significant use of operating cash.
Outlook, risks, and unusual items
- Management expected approximately $13 million of routine capital expenditures over the 12 months ending June 30, 2016, in addition to remaining commitments for Indiana dryer replacements. It stated that cash sources should cover budgeted capital spending and anticipated operating needs; no earnings or revenue guidance was provided.
- The February 2015 credit agreement increased facility capacity to $80 million, extended maturity to 2020, and reduced certain interest rates. A 100-basis-point rate increase was estimated to raise annual interest expense by $69 based on period-end borrowings.
- The DMI joint venture ceased normal operations effective June 30, 2015 and entered a one-year wind-down. DMI had been the sole source of Trutex/Wheatex textured wheat proteins; MGP arranged supply through Loryma and identified a U.S. tolling manufacturer. Supply continuity and the new arrangement remain important to monitor.
- ICP’s $4,112 insurance recovery boosted its reported results and MGP’s equity earnings; management cautioned that ICP’s contribution may not continue. ICP’s sales and average selling prices were lower year over year.
- The CFO was terminated May 28, 2015; management was conducting an external search and expected to fill the role by year-end. Related termination costs were $941, including $710 of severance expense and $231 of accelerated restricted-stock vesting. The CEO was performing the principal-financial-officer function. Management said disclosure controls were effective and reported no material change in internal control over financial reporting.
- The collective-bargaining pension plans were terminated after PBGC approval; the company funded $741 and reported no continuing obligation after June 30. Other exposures include volatility and availability of grain, flour, energy and oak barrels; production disruptions; ability to pass through input costs; ICP performance and limited influence over its decisions; and key-personnel and control risks. Management said ordinary-course legal proceedings were not expected to have a material adverse effect.
Investor verification priorities
- Assess whether margin gains from lower input costs, efficiency, and premium-product mix are sustainable, particularly as commodity costs and product demand change.
- Separate recurring ICP earnings from the nonrecurring insurance recovery and track ICP’s volume, pricing, financing, and future distributions.
- Monitor inventory growth, cash conversion, capital spending, and remaining Indiana dryer commitments against available liquidity.
- Verify continuity, quality, and economics of replacement Trutex/Wheatex supply during DMI’s wind-down.
- Track CFO succession, management transition, and internal-control coverage following the CFO’s departure.
- Reconcile the quarter’s 9,649 shares reported as purchased in the issuer-purchases table with management’s statement that there were no purchases under the $3.5 million repurchase authorization; the filing describes the shares as not purchased under the publicly announced plan.