MGP Ingredients, Inc. — Q3 2016 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2016; comparison is with the corresponding 2015 periods. Unless otherwise noted, dollar amounts are in thousands. MGP produces distilled spirits and other distillery products, as well as specialty and commodity starches and proteins.
Financial performance
| Metric | Q3 2016 | Q3 2015 | Nine months 2016 | Nine months 2015 |
|---|---|---|---|---|
| Net sales | $79,891 | $80,328 | $237,118 | $246,095 |
| Gross profit | $15,121 | $11,862 | $47,698 | $42,778 |
| Gross margin | 18.9% | 14.8% | 20.1% | 17.4% |
| Operating income | $11,525 | $6,365 | $31,377 | $22,776 |
| Net income | $9,532 | $6,771 | $22,899 | $19,712 |
| Diluted EPS | $0.55 | $0.38 | $1.33 | $1.10 |
| Operating cash flow | Not separately stated | Not separately stated | $1,844 | $12,798 |
Q3 sales declined 0.5%, while gross profit rose 27.5% and net income rose 40.8%. Nine-month sales fell 3.6%, while gross profit increased 11.5% and net income increased 16.2%. Operating margins were 14.4% for Q3 and 13.2% year to date, versus 7.9% and 9.3%, respectively, in 2015.
Distillery products generated Q3 sales of $66,664, essentially flat year over year, and gross profit of $12,364, up 19.2%. Premium beverage alcohol sales and warehouse revenue increased, while lower-margin industrial alcohol and co-product sales declined. Ingredient solutions Q3 sales decreased 2.8% to $13,227, but gross profit increased 85.0% to $2,757, helped by improved plant efficiency and lower input costs. For nine months, ingredient solutions sales fell 10.5% and gross profit fell 6.2%.
Cash, debt, and liquidity
- At September 30, 2016, cash was zero; current assets were $114,113 and current liabilities were $32,818, a reported excess of $81,295, largely consisting of inventory.
- Inventory was $75,611, up from $58,701 at December 31, 2015; barreled distillate rose to $44,971 from $28,278.
- Total debt was $45,466, net of unamortized loan fees, versus $33,460 at year-end 2015. The company reported $43,395 available under its credit agreement and compliance with covenants.
- Operating cash flow was $1,844 for the first nine months, down from $12,798. Capital expenditures were $12,666; investing cash use was $11,228. Financing provided $8,637, including net credit-facility borrowings.
Material changes and unusual items
- Q3 operating income included $3,385 of other operating income, net. The filing identifies a $2,550 legal settlement and an $871 gain on sale of long-lived assets as key items contributing to the increase.
- The company early-adopted stock-compensation accounting guidance, recognizing a $1,571 tax-effected excess tax benefit in Q3 income tax expense. Q3 effective tax rate was 19.5%, compared with 13.3% in the prior-year quarter; the comparison also reflects a prior-year valuation-allowance release.
- Equity-method earnings fell to $664 in Q3 from $1,562, and to $2,260 year to date from $6,010, primarily due to lower pricing and less favorable conditions at ICP; the prior-year nine-month period also included business-interruption insurance proceeds.
- The company began quarterly dividends in 2016, replacing the prior annual declaration. It declared a further $0.02 per share dividend in October, payable in December.
Outlook, risks, and contingencies
- Management expected approximately $20,000 of 2016 capital expenditures for facility improvements, expansion, maintenance, and safety projects. The approved Lawrenceburg warehouse expansion totaled $29,000, of which $17,676 had been spent by September 30. The project supports the stated five-year strategy to grow the whiskey category.
- Management said operating cash flow and the credit facility were expected to support budgeted capital spending and operating needs. No quantified earnings or revenue guidance is provided.
- A chemical release occurred at the Atchison plant on October 21, after quarter-end. Local officials reported injuries, mostly respiratory; the company was cooperating with authorities. Management considered a regulatory fine or penalty probable but could not estimate it. Private claims were possible but not estimable; insurance was expected to cover private damages subject to a $250 deductible, while regulatory penalties might not be covered.
- A federal excise-tax audit identified clerical and storage-loss support matters. The company considered a penalty probable but could not reasonably estimate the amount. Management did not expect aggregate liabilities from legal and regulatory proceedings to materially harm financial position or results.
- Input-cost exposure includes grain, wheat flour, and natural gas. The company estimated that a 100-basis-point increase in interest rates would raise annualized interest expense by $412 based on borrowings at September 30.
Important facts for investors to verify
- How much of the operating-income and EPS improvement came from the settlement, asset-sale gain, and stock-compensation tax benefit, and whether underlying margins persist.
- Whether cash conversion improves after the substantial working-capital use, particularly inventory growth and timing-related receivables and payables movements.
- Progress, remaining commitments, and expected returns on the $29,000 warehouse expansion and other capital projects.
- Developments and potential financial exposure from the Atchison chemical release and the TTB excise-tax audit.
- ICP earnings trends and the effects of pricing and market conditions on equity-method income.