MGPI

Business Context and Reporting Period

Company: MGP Ingredients, Inc.
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: April 1, 2007 (Third Quarter of Fiscal 2007)
Business Overview: MGP Ingredients is a fully integrated producer of ingredients (starches, proteins, mill feeds) and distillery products (food grade alcohol, fuel ethanol, distiller's grain, carbon dioxide). The company operates two primary segments: Ingredients and Distillery Products.

Key Financial Metrics

Material Changes vs. Prior Period

• Revenue Growth: Net sales increased 18% ($14.4 million) in Q3 2007 compared to Q3 2006, driven primarily by a 31% increase in Distillery Products sales. Ingredients sales declined 14% due to the loss of a major pet industry customer.
• Profitability: Net income rose 5% in Q3 2007 and 141% year-to-date. The Distillery segment generated $5.69 million in pre-tax income for the quarter, offsetting a $1.93 million loss in the Ingredients segment.
• Cost Pressures: Cost of sales increased 20% in Q3 due to higher grain costs (corn up ~65%, wheat up ~20%) and increased maintenance/repair costs for distillery upgrades. Natural gas costs decreased 21%.
• Segment Performance:
  • Distillery: Sales rose due to higher unit sales and prices for fuel and food-grade alcohol. Capacity improvements contributed to higher throughput.
  • Ingredients: Sales of specialty ingredients for non-food applications dropped 64% due to the loss of a major customer. However, sales of commodity wheat gluten increased 32% due to a pet food recall driving demand for US-sourced gluten.
• Liquidity: Cash and cash equivalents decreased from $14.5 million to $2.4 million, primarily due to $16.8 million in capital expenditures and $3.3 million in dividends paid.

Guidance, Outlook, and Risks

• Wheat Gluten Outlook: Management anticipates that increased production of wheat gluten, driven by the pet food recall, will impact results positively in the fourth quarter. Production rates could triple by the start of fiscal 2008 if demand remains high.
• Distillery Expansion: The company is implementing a plan to expand alcohol production capacity by approximately 15%, with a total projected investment of $10 million, scheduled for completion by late summer 2007.
• Capital Expenditures: The company has spent $16.8 million year-to-date and has commitments for an additional $12.6 million over the next 12 months.
• Energy Projects: The company is exploring a coal-fired steam generation facility for its Pekin, Illinois plant (estimated cost $60 million), but no decision has been made to proceed.
• Risks: Key risks include fluctuations in grain and energy costs, competitive market conditions, and the effectiveness of hedging programs. The company noted a significant deficiency in internal controls regarding the classification of employee benefit plans, which is being addressed.
• Legal: A settlement of $500,000 regarding emissions at the Pekin, Illinois location was approved and paid in March 2007. Litigation against Mars, Incorporated regarding pet food ingredients is ongoing.

Investor Verification Checklist

• Customer Concentration: Verify the extent of the loss of the major pet industry customer and the sustainability of the new demand for wheat gluten following the pet food recall.
• Raw Material Hedging: Review the effectiveness of hedging strategies given the significant rise in corn and wheat prices (65% and 20% respectively) and the reduction in hedged corn volume (24% in Q3 vs 42% prior year).
• Capital Allocation: Assess the return on the $10 million distillery expansion and the potential $60 million coal-fired facility investment.
• Debt Covenants: Confirm compliance with financial covenants, specifically the current ratio (1.5 to 1) and debt-to-tangible net worth ratio (not more than 2.5 to 1).
• Internal Controls: Monitor the remediation of the internal control deficiency regarding the classification of defined benefit vs. defined contribution pension plans.