MGP Ingredients, Inc. — Q2 2017 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2017; filed August 3, 2017. MGP produces distilled spirits and alcohol, distillery co-products, and specialty and commodity wheat starches and proteins. Unless noted, dollar amounts below are in millions.
Financial performance
| Metric | Q2 2017 | Q2 2016 | Six months 2017 | Six months 2016 |
|---|---|---|---|---|
| Net sales | $85.8 | $80.4 | $172.9 | $157.2 |
| Gross profit / margin | $18.8 / 22.0% | $15.5 / 19.3% | $37.9 / 21.9% | $32.6 / 20.7% |
| Operating income / margin | $10.5 / 12.3% | $9.1 / 11.4% | $21.9 / 12.7% | $19.9 / 12.6% |
| Net income | $6.4 | $6.3 | $15.0 | $13.4 |
| Diluted EPS | $0.37 | $0.37 | $0.87 | $0.77 |
| Operating cash flow | — | — | $10.8 | $0.2 |
Q2 net sales rose 6.7%; gross profit increased 21.2%, while SG&A grew 29.8% to $8.3 million. Net income was nearly flat: stronger operations and a lower tax rate were offset by an $0.8 million equity-method loss, versus $1.1 million of earnings a year earlier. The six-month effective tax rate was 27.8%, versus 35.8% in 2016, reflecting share-based compensation tax benefits, state credits, and a valuation-allowance release.
Distillery products drove much of the growth: Q2 segment sales rose 5.9% and gross profit 16.8%. Premium beverage alcohol sales increased 15.2%, while industrial alcohol and distillers co-products declined; warehouse services sales rose 28.2%. Ingredient solutions sales increased 10.3% and gross profit 53.7%, with improved margins attributed to lower input costs and higher volumes. Six-month sales growth was 10.8% for distillery products and 6.1% for ingredient solutions.
Cash, debt, and investment
- At June 30, cash was $7.9 million; current assets were $134.4 million and current liabilities $31.7 million, including $85.6 million of inventory. Management reported working capital of $102.7 million.
- Total debt, net of unamortized loan fees, was $43.7 million, up from $36.0 million at year-end 2016. The company reported $49.4 million of additional borrowing availability and compliance with credit covenants.
- Six-month investing cash use was $9.6 million, including $9.9 million of property and equipment additions. Management expected approximately $22 million of 2017 capital expenditures. The $29 million Lawrenceburg-area whiskey warehouse expansion had incurred $22.7 million through June 30.
- Cash rose by $6.3 million during the six months. Operating cash flow improved substantially from the prior-year period, helped by higher net income and investee distributions, partly offset by increases in receivables and inventory.
Developments, outlook, and risks
- ICP divestiture: On July 3, 2017, MGP sold its 30% interest in Illinois Corn Processing. Consideration included $9.0 million cash and a secured $14.0 million note due in 18 months, bearing interest at LIBOR plus a margin that steps up from 5% to 8% and then 10%. MGP also received distributions totaling $7.4 million in June. The note’s collection and credit risk merit attention.
- Capital returns: On August 1, the board declared a special $0.85-per-share dividend, approximately $14.6 million in total, payable September 8, plus a regular $0.04-per-share dividend. Management expected to fund the special dividend with ICP-related cash proceeds received in June and July. The company also paid $0.08 per share in regular dividends during the first half.
- Management outlook: Management said cash from operations and the credit facility should be adequate for budgeted capital spending and operating needs, and expected about $22 million of 2017 capital expenditures. The filing provides no specific revenue or earnings guidance. Management cited strong demand for premium beverage alcohol and continued investment in whiskey capacity.
- Contingencies: The EPA alleged that Lawrenceburg whiskey warehouses were built without a required Clean Air Act permit; no penalty had been demanded at filing, and the company said a loss was probable but not estimable. Separately, the EPA indicated after quarter-end that it intended to seek about $0.25 million related to the 2016 Atchison chemical release; settlement discussions were ongoing and no accrual was recorded. OSHA’s $0.138 million penalty related to that incident was settled for $0.075 million. Private claims and other regulatory exposure remained difficult to estimate; insurance coverage is subject to terms and a deductible.
- Product risk: MGP’s Fibersym patent expired June 6, 2017, increasing competition risk. FDA confirmation of the products’ dietary-fiber status remained under review; management said the FDA’s planned extension of food-labeling compliance deadlines mitigated timing risk.
- Other exposure: The company relies on grain, wheat flour, and natural gas supply arrangements and has variable-rate borrowings. Management estimated a 100-basis-point rate increase would raise annualized interest expense by $0.422 million, based on June 30 borrowings.
Important facts for investors to verify
- Terms, collateral, repayment prospects, and actual cash collection on the $14.0 million ICP note, and the accounting effects of the completed sale.
- Whether the $14.6 million special dividend and planned capital spending leave adequate liquidity after considering debt and working-capital needs.
- Whether improved operating margins and premium beverage alcohol demand persist, and how much of the lower tax rate reflects nonrecurring benefits.
- Outcomes and potential costs of the EPA matters, Atchison-related claims, and insurance recoveries.
- Competitive effects of the Fibersym patent expiration and the FDA’s eventual dietary-fiber determination.