MGP Ingredients, Inc. — Q2 2019 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2019. MGP produces distilled spirits and industrial alcohol, and specialty wheat protein and starch ingredients. Financial amounts below are in millions of dollars unless otherwise noted.
Financial performance
| Metric | Q2 2019 | Q2 2018 | Six months 2019 | Six months 2018 |
|---|---|---|---|---|
| Sales | $90.5 | $88.3 | $179.6 | $176.2 |
| Gross profit | $19.5 | $19.4 | $36.2 | $38.4 |
| Operating income | $10.9 | $11.1 | $19.4 | $21.5 |
| Net income | $7.9 | $7.5 | $17.6 | $16.5 |
| Diluted EPS | $0.46 | $0.44 | $1.03 | $0.96 |
| Gross margin | 21.6% | 22.0% | 20.1% | 21.8% |
| Operating margin | 12.0% | 12.6% | 10.8% | 12.2% |
Q2 sales grew 2.5%, while gross profit was nearly flat and operating income declined 2.3%, reflecting higher SG&A and lower distillery-products gross profit. Net income rose 5.1%, primarily because the effective tax rate fell to 25.0% from 30.6%. For the first half, sales increased 1.9%, but gross profit fell 5.8% and operating income fell 9.9%; net income increased 7.2% as the effective tax rate dropped to 6.3% from 21.7%. The filing attributes the lower year-to-date tax expense mainly to tax effects of vested share-based awards and the absence of a prior-year tax-estimate adjustment related to an earlier investment sale.
Segments and operating drivers
- Distillery Products: Q2 sales rose 1.9% to $74.0 million, while gross profit declined 1.1% to $16.5 million and margin fell to 22.3% from 23.0%. Industrial alcohol and warehouse services grew; brown goods, fuel-grade alcohol, and distillers feed/co-products declined. Management cited oversupply and difficulty passing input-cost increases through in some markets.
- Ingredient Solutions: Q2 sales increased 5.6% to $16.5 million and gross profit increased 9.3% to $3.0 million. Higher commodity starch and protein sales more than offset lower specialty-product sales; the specialty wheat protein decline reflected the loss of a large customer. For the first half, segment sales rose 6.2%, but gross profit fell 24.0% to $4.4 million and margin declined to 14.3% from 20.0%, due to higher input and production costs, customer-related volume loss, and flood-related costs.
Cash flow, debt and liquidity
- First-half operating cash flow was $3.1 million, versus $1.2 million a year earlier. Inventory absorbed $9.2 million of cash and refundable income taxes absorbed $4.7 million.
- Investing cash outflow was $7.4 million, including $6.2 million of property, plant and equipment additions. Financing provided $1.4 million. Cash declined $2.9 million to $2.2 million.
- At June 30, current assets were $169.0 million and current liabilities were $32.1 million; inventory was $118.0 million. MGP reported working capital of $136.9 million and $148.4 million available under its $150 million revolving facility.
- Debt, net of unamortized fees, was $42.5 million, up from $32.0 million at year-end 2018. The increase included a $20 million fixed-rate note issued in April 2019; revolver borrowings were $1.6 million. The company reported compliance with debt covenants.
- Stockholders’ equity was $212.4 million. First-half dividends and dividend equivalents totaled $3.4 million; the Board declared a further $0.10-per-share dividend payable August 30, 2019.
Outlook, risks and unusual items
- Management expects approximately $23 million of capital expenditures in 2019. The American whiskey warehouse expansion is estimated at $51.8 million in total; approximately $45.3 million had been incurred by June 30, with completion expected by year-end 2020.
- Management expects operating cash flow and available credit to support anticipated operating needs and budgeted capital expenditures. It also plans to invest in growth, including building inventories of aged premium whiskey to meet expected demand. No full-year revenue or earnings guidance is provided in the filing text.
- A $25 million share repurchase authorization was approved in February 2019, but no shares had been repurchased under the program through June 30. Treasury stock purchases reported in the period principally covered withholding taxes on vested equity awards.
- The company faces federal Clean Air Act charges related to a 2016 chemical release at its Atchison facility. The statutory maximum fine could be up to $1.5 million; MGP intends to defend itself and recorded no accrual, citing uncertainty and immateriality to the reported periods. Private claims have also been brought or may be brought; damages cannot currently be reasonably estimated. Insurance coverage is subject to a $250,000 deductible, and recovery is not assured.
- Commodity input costs, oversupply in alcohol markets, customer concentration or loss, and interest-rate movements are relevant risks. Management estimated that a 100-basis-point rise in rates would increase annualized interest expense by about $81,000 based on variable-rate borrowings at period-end.
- Adoption of lease accounting in 2019 resulted in recognition of $6.2 million of operating lease assets and liabilities at June 30; the company stated adoption did not affect earnings or cash flows.
Important facts for investors to verify
- Whether the unusually low first-half effective tax rate is sustainable; reported earnings growth exceeded operating-income growth and depended materially on tax effects.
- Progress on Ingredient Solutions margins, including the effects of the lost specialty-protein customer, input costs, and flood-related costs.
- Distillery-product pricing and margins amid market oversupply, and whether whiskey demand and warehouse expansion support the planned growth and inventory investment.
- Cash conversion, inventory growth and liquidity needs as capital spending proceeds; reported cash was $2.2 million despite substantial revolver availability.
- Developments in the Atchison legal matters, potential penalties or private damages, and the scope and timing of insurance recoveries.