MGP Ingredients, Inc. — Q3 2012 Form 10-Q
Business context and period. This report covers the quarter and nine months ended September 30, 2012; the company’s fiscal year ends December 31. MGP produces distillery products, specialty and commodity ingredients, and other products. Results include the Indiana distillery acquired in December 2011. Unless stated otherwise, amounts below are in millions of dollars.
Financial performance
| Metric | Quarter ended Sep. 30, 2012 | Prior-year quarter | Nine months ended Sep. 30, 2012 | Prior-year nine months |
|---|---|---|---|---|
| Net sales | $76.1 | $76.1 | $248.0 | $209.1 |
| Gross profit / margin | $6.1 / 8.0% | $2.8 / 3.7% | $17.6 / 7.1% | $6.5 / 3.1% |
| Operating income (loss) | $0.9 | $(2.6) | $(1.9) | $(9.8) |
| Net income (loss) | $0.4 | $(5.5) | $1.4 | $(15.1) |
| Basic and diluted EPS | $0.02 | $(0.33) | $0.08 | $(0.91) |
| Operating cash flow | Not separately presented for the quarter | $(7.5) | $(9.8) |
- Quarterly net sales were essentially flat. Nine-month sales rose 18.6%, driven mainly by higher distillery product volumes and the Indiana distillery acquisition; ingredient solutions sales declined.
- Quarterly gross margin improved substantially, aided by favorable changes in the fair value of open commodity derivatives, lower flour and natural-gas costs, and improved pricing. For the quarter, open commodity contracts had a reported favorable $1.8 impact to cost of sales, versus an unfavorable $2.6 impact a year earlier. Corn costs were higher.
- Nine-month net income included a $4.1 pretax gain from selling a 20% interest in Illinois Corn Processing (ICP). The comparison also reflects improved joint-venture results and derivative marks, partially offset by higher SG&A and interest expense.
- Quarterly SG&A rose 19% to $6.0; nine-month SG&A rose 28% to $20.1, mainly reflecting acquisition-related personnel costs, incentives, professional fees and reorganization.
- Nine-month investing cash flow was positive $4.1, including $9.1 proceeds from the ICP interest sale and $3.2 from asset dispositions, against $7.7 of cash capital expenditures. Financing cash flow was positive $3.0.
Balance sheet, liquidity and debt
- At September 30, cash and cash equivalents were zero; restricted cash was $0.1. Working capital was $21.1, compared with $18.9 at December 31, 2011.
- Total debt was $33.6, including $26.4 outstanding on the revolving facility and $7.3 of long-term debt and current maturities. Total debt was $29.7 at December 31, 2011. The company reported $16.1 available under the facility at September 30, after letters of credit and other adjustments.
- Operating cash outflow remained significant, and inventory increased $3.4 year to date. Management budgeted $9.0 for routine capital expenditures in the twelve months through September 30, 2013; $1.3 of capital-asset purchase commitments remained at quarter-end.
- The company paid a $0.05-per-share dividend in April 2012, totaling $0.9.
Material developments, outlook and risks
- Covenant breach and waiver: The company failed its September-quarter adjusted net income covenant under the then-existing credit agreement and obtained a waiver from its primary lender. Management said future covenant compliance would require improved operating results.
- Refinanced credit facility: On November 2, 2012, the company entered a five-year, $55.0 million revolving facility maturing November 2, 2017. At signing, $17.3 was available after letters of credit. Borrowings remain subject to a borrowing base; the agreement includes availability and fixed-charge coverage tests and may restrict dividends and other payments. The lender has discretion over borrowing-base terms.
- Commodity exposure: Management reported tight commodity supply and corn prices near historic highs during summer 2012 amid Midwest drought. Corn purchase commitments through September 2013 totaled $48.3; natural-gas commitments totaled $3.5. Grain supply agreements allow purchases up to 12 months forward. The company de-designated its corn cash-flow hedges in February and had no corn futures designated as cash-flow hedges at quarter-end; derivative marks can still cause earnings volatility.
- Operations and strategy: The company implemented SAP at the Indiana distillery on July 1, 2012. Management said it expected available cash sources to support budgeted capital spending and anticipated operating needs. No specific earnings or revenue guidance was provided.
- Other notable items: A plan change reduced future retiree health and life-insurance benefits for certain non-union employees. Management reported ordinary-course legal proceedings were not expected to have a material adverse effect. Disclosure controls were assessed as effective; management said SAP-related control changes did not impair the control environment.
- Forward-looking risks include facility disruptions, grain and energy costs, hedge effectiveness, integration of the Indiana distillery, competition, passing input-cost increases to customers, ICP profitability, covenant compliance, operating efficiencies, government actions and changes in consumer preferences.
Key facts for investors to verify
- The status of covenant compliance under the November 2012 facility, including borrowing-base availability, fixed-charge coverage and any resulting payment restrictions.
- Whether operating cash flow improves and the company can fund capital spending and working capital needs without materially increasing borrowings.
- How much reported margin improvement reflects sustainable pricing and operating performance versus non-cash derivative gains and other unusual items.
- Performance and integration costs of the Indiana distillery, and the ongoing profitability and cash exposure associated with the 30% ICP interest.
- The effect of elevated corn prices, supply commitments and reduced use of designated hedges on future margins and earnings volatility.