MGP Ingredients, Inc. — Q3 2018 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2018; comparisons are to the corresponding 2017 periods. Dollar amounts below are in millions unless otherwise stated. MGP produces distilled spirits and industrial alcohol, and specialty and commodity wheat protein and starch ingredients.
Financial performance
| Metric | Q3 2018 | Q3 2017 | Nine months 2018 | Nine months 2017 |
|---|---|---|---|---|
| Net sales | $95.0 | $86.3 | $271.2 | $259.3 |
| Gross profit / margin | $19.6 / 20.6% | $18.6 / 21.6% | $58.0 / 21.4% | $56.5 / 21.8% |
| Operating income / margin | $12.0 / 12.6% | $10.5 / 12.1% | $33.5 / 12.4% | $32.4 / 12.5% |
| Net income | $9.0 | $14.1 | $25.5 | $29.2 |
| Diluted EPS | $0.52 | $0.82 | $1.48 | $1.70 |
| Operating cash flow | Not provided for quarter | Not provided for quarter | $1.7 | $16.4 |
Quarterly sales rose 10.1%, while gross margin slipped 1.0 percentage point. Operating income increased 14.7%, supported by stronger Ingredient Solutions gross profit and lower SG&A; Distillery Products gross profit declined. Net income fell 36.3%, mainly because Q3 2017 included an $11.4 million gain on the sale of MGP’s Illinois Corn Processing (ICP) investment. Nine-month sales increased 4.6% and operating income 3.6%, but net income fell 12.8%, also reflecting the absence of that gain. The 2017 nine-month period additionally included a $0.3 million ICP investment loss.
- Segments: Q3 Distillery Products sales increased 8.3% to $78.3 million, but gross profit declined 1.4% to $16.3 million and margin fell to 20.8% from 22.8%. Higher Lawrenceburg production costs and weaker industrial-alcohol margins weighed on results. Ingredient Solutions sales rose 19.3% to $16.7 million; gross profit grew 56.8% to $3.3 million and margin improved to 20.0% from 15.2%, aided by plant efficiencies.
- Cash flow and investment: Nine-month operating cash flow was $1.7 million, down from $16.4 million. Receivables and inventory increases, incentive-compensation payments, and timing of payables and tax payments were significant uses of cash. Capital expenditures were $18.9 million; investing cash outflow was $18.9 million, versus $9.2 million of investing cash inflow in 2017, which included a $22.8 million ICP investment return.
- Balance sheet and liquidity: At September 30, cash was zero, current assets were $161.2 million, current liabilities $31.8 million, and inventory $107.3 million. Reported total indebtedness, net of unamortized fees, was $45.1 million, versus $24.6 million at year-end 2017. Revolver borrowings were $24.0 million, with $126.0 million available under the $150 million facility. The company reported compliance with debt covenants and said available funding and expected operating cash flows should support requirements.
- Tax and dividends: Effective tax rates were 22.9% for Q3 and 22.1% year to date, versus 34.6% and 31.3% in 2017, respectively. The company said its accounting for the 2017 Tax Act remained incomplete. Nine-month dividends and equivalents totaled $4.1 million, compared with $16.7 million in 2017, which included a $0.85-per-share special dividend. A $0.08-per-share quarterly dividend was declared after quarter-end.
Outlook, risks, and notable items
- No specific earnings or revenue guidance is provided. Management expects approximately $29 million of 2018 capital expenditures. The American whiskey warehouse expansion was increased from $33.8 million to approximately $51.8 million; about $33 million had been incurred by September 30, with completion estimated by year-end 2020.
- Management cited growth in American whiskey demand and is building aged-whiskey inventories. Commodity price volatility, production costs, and interest-rate changes are risks; a 100-basis-point increase in variable borrowing rates was estimated to add $208,000 of annualized interest expense, based on borrowings at quarter-end.
- Following the 2016 Atchison chemical release, OSHA’s $138,000 assessment was settled for $75,000 in 2017. EPA indicated it intended to seek approximately $250,000 in civil penalties; negotiations were paused pending its criminal investigation. The company had not accrued the proposed civil penalty, describing it as not material, and could not reasonably estimate potential private damages. Insurance coverage and recovery timing are uncertain.
- Management reported effective disclosure controls and no material changes in internal control over financial reporting. The company adopted the new revenue standard in 2018 with no financial-statement impact.
Important facts for investors to verify
- Whether operating cash generation recovers as receivables and inventory grow, and how the warehouse expansion is funded and delivered within budget.
- Whether distillery production costs and industrial-alcohol margins stabilize, and whether Ingredient Solutions’ margin gains persist.
- The final outcome and potential cost of the EPA investigation and private claims related to the Atchison release, including applicable insurance coverage.
- The effect of completing Tax Act accounting and adopting the new lease standard, particularly for the company’s rail-car leases.