MGP Ingredients, Inc. — Q1 2017 Form 10-Q
Reporting period: Three months ended March 31, 2017; comparative period is Q1 2016. Unless stated otherwise, dollar amounts are in millions. The filing is unaudited.
Business context
MGP produces distilled spirits and industrial alcohol, distillery co-products and warehouse services, as well as specialty and commodity wheat starches and proteins. Its reportable segments are Distillery Products and Ingredient Solutions.
Financial performance
| Metric | Q1 2017 | Q1 2016 | Change |
|---|---|---|---|
| Net sales | $87.169 | $76.835 | +13.4% |
| Gross profit / margin | $19.041 / 21.8% | $17.046 / 22.2% | Profit +11.7%; margin down 0.4 percentage points |
| Operating income / margin | $11.392 / 13.1% | $10.725 / 14.0% | Income +6.2%; margin down 0.9 percentage points |
| Net income | $8.678 | $7.059 | +22.9% |
| Diluted EPS | $0.50 | $0.41 | +22.0% |
| Cash from operations | $(0.942) | $(1.641) | Deficit narrowed by $0.699 |
| Capital spending | $6.454 cash outflow | $3.053 cash outflow | Higher investment |
Premium beverage alcohol sales rose 30.4%; total Distillery Products sales increased 15.8%, while Ingredient Solutions sales rose 1.7%. Distillery gross margin declined to 22.5% from 23.3%; Ingredient Solutions gross margin improved to 18.4% from 16.9%.
Financial position and liquidity
- At March 31, 2017, cash was zero; receivables were $36.387 million and inventory was $79.988 million. Current assets exceeded current liabilities by $87.275 million, largely reflecting inventory.
- Total debt, net of unamortized loan fees, was $43.693 million, up from $36.001 million at December 31, 2016. Revolver borrowings were $24.735 million. The company reported $50.262 million of additional borrowing availability and compliance with credit agreement covenants.
- Financing activities provided $5.827 million, including net borrowings under the credit agreement. Cash declined by $1.569 million during the quarter.
- Share repurchases used $1.131 million and dividend payments used $0.688 million. The quarterly dividend was $0.04 per share; a subsequent $0.04 dividend was declared for payment in June 2017.
Material changes and management commentary
Net sales growth was led by premium beverage alcohol and increased whiskey storage services. Lower sales of industrial alcohol, fuel-grade alcohol, distillers feed and related co-products partly offset that growth. Ingredient Solutions growth reflected higher starch and commodity protein sales, partly offset by lower specialty wheat protein sales. Management attributed the increase in gross profit to both segments, while higher personnel, advertising and promotion costs raised SG&A by 21.0% and restrained operating income growth.
The effective tax rate fell to 24.7% from 35.4%. Management attributed the principal reduction to the treatment of a February 2017 share-based compensation event under ASU 2016-09. The filing’s EPS bridge attributes $0.07 of the year-over-year increase to this tax effect, so reported earnings growth benefited from a discrete tax item.
Outlook, commitments and risks
- Management expected approximately $22 million of 2017 capital expenditures for facility improvements and expansion, maintenance and environmental, health and safety projects. The company had incurred $22.231 million of the approved $29 million Lawrenceburg warehouse expansion as of March 31, 2017.
- Management said operating cash flow and the credit facility were expected to support budgeted capital expenditures and anticipated operating needs. No specific earnings or revenue guidance was provided.
- Open purchase commitments were $68.090 million for raw materials and packaging, extending through February 2018, and $2.523 million for capital assets.
- The EPA alleged that Lawrenceburg whiskey warehouse construction began without a required Clean Air Act permit. No penalty demand had been made; management considered a penalty probable but could not reasonably estimate the loss, and did not expect a material adverse effect.
- Following an October 2016 chemical release at Atchison, OSHA issued a $0.138 million penalty in April 2017; management was reviewing the citation. EPA and state investigations and potential private claims remained unresolved, and related amounts were not reasonably estimable. Insurance may cover private damages subject to a $0.250 million deductible; coverage of regulatory penalties was uncertain.
- Management cited commodity-price exposure, variable-rate borrowing and the risk that actual results may differ from forward-looking statements. A 100-basis-point rate increase was estimated to raise annualized interest expense by $0.385 million based on March 31 borrowings.
Key facts for investors to verify
- Whether premium beverage alcohol demand and whiskey storage revenue continue to grow, and whether margin pressure from product mix and SG&A persists.
- How much of the $0.50 diluted EPS and year-over-year earnings increase is sustainable without the discrete share-based compensation tax benefit.
- Working-capital needs, particularly receivables growth, high barreled-distillate inventory and negative operating cash flow, alongside ongoing capital spending.
- Debt utilization, borrowing-base availability and covenant compliance as the warehouse expansion and other investments proceed.
- Potential financial exposure and insurance recoveries related to the EPA warehouse notice, Atchison chemical release and associated proceedings.