MGP Ingredients, Inc. — Q1 2019 Form 10-Q
Reporting period: Three months ended March 31, 2019, compared with Q1 2018. MGP produces distilled spirits and industrial alcohol, as well as specialty and commodity wheat protein and starch ingredients. Unless noted, financial amounts below are in millions of dollars.
Financial performance
| Metric | Q1 2019 | Q1 2018 | Change |
|---|---|---|---|
| Sales | $89.1 | $88.0 | +1.3% |
| Gross profit / margin | $16.7 / 18.7% | $19.0 / 21.5% | Profit down 12.1%; margin down 2.8 percentage points |
| Operating income / margin | $8.5 / 9.6% | $10.4 / 11.8% | Income down 18.1%; margin down 2.2 points |
| Income before taxes | $8.3 | $10.2 | Down 18.9% |
| Income tax (benefit) expense | ($1.5) | $1.3 | Effective rate: (17.7)% vs. 12.3% |
| Net income / diluted EPS | $9.7 / $0.57 | $8.9 / $0.52 | Net income up 8.9% |
| Operating cash flow | ($3.8) | $0.9 | Declined $4.7 |
Net income and EPS rose despite weaker operating results, principally because of the quarterly tax benefit, including tax effects of vested share-based awards. The filing attributes approximately $0.11 per share of the year-over-year EPS change to the tax impact of share-based compensation.
Segments and drivers
- Distillery Products: Sales were $74.6 million, up 0.3%; gross profit was $15.2 million, down 4.0%, and gross margin declined to 20.4% from 21.3%. Higher white-goods, industrial alcohol, co-product, and warehouse-service sales were partly offset by lower brown-goods and fuel-grade alcohol sales. Management said higher input costs were not fully passed through amid market oversupply.
- Ingredient Solutions: Sales were $14.5 million, up 6.9%, but gross profit fell 53.9% to $1.4 million and margin fell to 9.8% from 22.7%. Management cited higher input and flood-related production costs and the loss of a large specialty wheat protein customer; increased commodity wheat protein sales partly offset these pressures.
Cash, liquidity and debt
Cash was zero at March 31, versus $5.0 million at year-end. Current assets exceeded current liabilities by $129.4 million, but included $111.3 million of inventory, including $79.5 million of barreled distillate. Operating cash use reflected increased receivables, refundable income taxes and lower accounts payable, partly offset by a smaller inventory build. Investing cash use was $4.9 million, including $3.7 million of property and equipment additions. Financing provided $3.7 million, including $11.0 million of net revolver proceeds and $5.5 million used for tax withholding on vested equity awards.
Debt carrying value, net of unamortized fees, was $43.0 million, compared with $32.0 million at December 31, 2018; gross borrowings were $43.5 million. Revolver borrowings were $22.0 million, with $128.0 million available under the $150 million facility. The company reported compliance with its debt covenants. Management said available liquidity and expected operating cash generation should cover anticipated operating needs and budgeted capital spending.
Outlook, material items and risks
- Management expects approximately $23 million of 2019 capital expenditures. The whiskey warehouse expansion is now estimated at $51.8 million; about $45 million had been incurred by March 31, with completion expected by year-end 2020.
- The company is building aged whiskey inventory to participate in expected category growth; this strategy and commodity-price increases can require significant cash. The filing gives no quantified revenue or earnings guidance.
- On February 25, 2019, the board authorized up to $25 million of share repurchases over three years. No shares had been repurchased under that program by March 31. The quarter’s reported treasury-share purchases were for employee tax withholding.
- Legal matters relate to the 2016 Atchison chemical release. An EPA civil penalty of approximately $250,000 was proposed, with no accrual recorded. A March 2019 Clean Air Act indictment named a former corporate-lineage entity; the company or a subsidiary may face charges, with a stated statutory maximum fine of $1.5 million. Private claims are also possible, and damages could not be reasonably estimated. Insurance may cover some claims, subject to terms and a $250,000 deductible for private-plaintiff damages.
- Key operating risks discussed include input-cost volatility, market oversupply limiting price recovery, flood-related costs, customer concentration or loss, and interest-rate exposure. Management estimated a 100-basis-point rise in variable rates would add about $143,000 of annualized interest expense based on March 31 borrowings.
Investor verification points
- Whether Ingredient Solutions can restore margins after the customer loss and flood-related cost increases.
- Whether distillery products pricing can recover input-cost inflation and how whiskey inventory growth affects cash conversion.
- Receivables collections, operating cash flow, and the pace of revolver borrowing as capital spending continues.
- Actual warehouse-expansion costs and timing versus the $51.8 million estimate and year-end 2020 target.
- Developments, potential costs, and insurance recoveries concerning the Atchison release proceedings.
- Whether the unusually favorable Q1 tax rate is repeatable; the filing notes interim tax rates can change with discrete items.