MGP Ingredients, Inc. — Q3 2019 Form 10-Q
Business context and reporting period. MGP is a producer of distilled spirits and wheat-based specialty and commodity ingredients, with Distillery Products and Ingredient Solutions segments. This unaudited filing covers the quarter and nine months ended September 30, 2019; comparisons are to the corresponding 2018 periods. Dollar amounts below are in millions unless noted.
Financial performance
| Metric | Q3 2019 | Q3 2018 | Nine months 2019 | Nine months 2018 |
|---|---|---|---|---|
| Sales | $90.7 | $95.0 | $270.3 | $271.2 |
| Gross profit / margin | $18.8 / 20.7% | $19.6 / 20.6% | $55.0 / 20.3% | $58.0 / 21.4% |
| Operating income / margin | $11.6 / 12.8% | $12.0 / 12.6% | $31.0 / 11.5% | $33.5 / 12.4% |
| Net income | $8.2 | $9.0 | $25.8 | $25.5 |
| Diluted EPS | $0.48 | $0.52 | $1.51 | $1.48 |
Q3 sales fell 4.6%, operating income fell 3.4%, and net income fell 8.8% year over year. The higher gross and operating margins in Q3 were slight improvements; year-to-date gross and operating margins contracted. Q3 net income was also affected by a higher effective tax rate of 26.9% versus 22.9%, which management attributed primarily to discrete tax impacts related to legal matters. The nine-month effective tax rate was 14.0% versus 22.1% in 2018, supporting the increase in year-to-date EPS despite lower operating income.
Segment performance and key drivers
- Distillery Products: Q3 sales decreased 6.4% to $73.3 million and gross profit decreased 2.2% to $15.9 million; gross margin rose to 21.7% from 20.8%. Lower brown-goods, industrial-alcohol and fuel-grade-alcohol sales were partly offset by growth in white goods, co-products and warehouse services. Management cited lower brown-goods volumes and oversupply pressures in white goods and industrial alcohol; lower Lawrenceburg production costs and co-products partly offset these effects.
- Ingredient Solutions: Q3 sales increased 4.2% to $17.4 million, but gross profit fell 13.4% to $2.9 million and gross margin declined to 16.6% from 20.0%. Specialty starch and protein sales grew, but commodity sales fell. Management attributed weaker gross profit principally to the loss of a large specialty wheat-protein customer.
- For the first nine months, Distillery Products sales declined 1.5% and gross profit fell 2.4%; Ingredient Solutions sales rose 5.5%, while its gross profit declined 20.1%, reflecting customer loss and higher input costs.
Cash flow, liquidity and debt
- Nine-month operating cash flow was $12.4 million, versus $1.7 million in 2018. Management attributed much of the improvement to timing of customer collections and cash disbursements; inventory growth, including barreled distillate, used $17.4 million of cash.
- Investing cash outflow was $11.6 million, including $10.4 million of property and equipment additions. Financing cash outflow was $1.5 million. Cash decreased $0.6 million to $4.4 million.
- At September 30, current assets were $175.6 million and current liabilities were $35.1 million, producing working capital of $140.5 million. Inventory was $126.2 million, including $95.2 million of barreled bourbon and whiskey.
- Net debt carrying value was $41.3 million, compared with $32.0 million at year-end 2018. The company issued $20.0 million of 3.80% notes due 2029 in April 2019. Revolver borrowings were $0.5 million, with $149.5 million available under the $150 million facility. The company reported compliance with debt covenants.
- The company paid $0.30 per share in dividends during the nine-month period. No shares were repurchased under the February 2019 $25 million repurchase authorization through September 30; certain share purchases were for employee tax withholding.
Outlook, risks and unusual items
- No earnings or revenue guidance is provided in the supplied filing text. Management expects approximately $19.5 million of 2019 capital expenditures. The expanded whiskey-warehouse project totals approximately $51.8 million, of which about $46.4 million had been incurred by September 30; completion was estimated by year-end 2020.
- Management said operating cash flow and available borrowing capacity should fund budgeted capital spending and anticipated operating needs for the foreseeable future. It also plans to build aged-whiskey inventories to serve anticipated American whiskey demand, tying up cash and exposing the company to inventory and commodity-cost changes.
- Legal matters arose from the October 2016 chemical release at the Atchison facility. As of the filing, the company had reached an EPA administrative penalty resolution for $251,000 and a DOJ plea agreement involving a $1.0 million fine; both amounts were accrued at September 30. Private plaintiffs may seek damages, which the company could not reasonably estimate. Insurance is expected to cover private claims subject to a $250,000 deductible, but recovery and coverage of fines are uncertain.
- Other disclosed exposures include volatility in grain, wheat-flour and natural-gas costs and interest rates. A 100-basis-point increase in variable rates was estimated to increase annual interest expense by $9,000 based on borrowings at quarter-end. The filing reported no material change in risk factors from the 2018 Form 10-K.
Important facts for investors to verify
- Whether weaker brown-goods demand and oversupply in alcohol markets persist, and how they affect Distillery Products volumes and margins.
- Whether Ingredient Solutions replaces the lost large customer and recovers segment profitability after lower margins and higher input costs.
- How whiskey inventory accumulation, warehouse-project spending and capital expenditures affect cash generation and borrowing needs.
- The final terms, payment and insurance treatment of the Atchison-related legal matters, and the extent of any private-plaintiff claims.
- Whether the unusually low year-to-date tax rate is repeatable; management identifies share-award tax effects and other items as contributors.