Document


UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C.  20549
 
FORM 10-Q 

(Mark One)
 
[ X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2018  
or
 
[  ]  TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from _________________________ to _________________________________
 
Commission File Number:  0-17196
http://api.tenkwizard.com/cgi/image?quest=1&rid=23&ipage=12384771&doc=12 
MGP INGREDIENTS, INC.
(Exact name of registrant as specified in its charter) 

KANSAS
45-4082531
(State or other jurisdiction of incorporation or organization)
(I.R.S. Employer Identification No.)
 
 
100 Commercial Street, Atchison, Kansas
66002
(Address of principal executive offices)
(Zip Code)
 
(913) 367-1480
(Registrant’s telephone number, including area code)
 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  [X] Yes [  ] No
 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). [X ] Yes [  ] No
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an "emerging growth company."  See definition of "large accelerated filer", "accelerated filer" and "smaller reporting company" in Rule 12b-2 of the Exchange Act.
[  ] Large accelerated filer                                                         [X] Accelerated filer
[  ]  Non-accelerated filer (Do not check if smaller reporting company   [ ] Smaller Reporting Company
[ ] Emerging growth company

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. [ ]
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). [ ]Yes [X] No
 
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date. 

16,847,737 shares of Common Stock, no par value as of July 26, 2018



INDEX
 
Page
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 

METHOD OF PRESENTATION

Throughout this Report, when we refer to "the Company," "MGP," "we," "us," "our," and words of similar import, we are referring to the combined business of MGP Ingredients, Inc. and its consolidated subsidiaries, except to the extent that the context otherwise indicates. In this document, for any references to Note 1 through Note 10, refer to the Notes to Unaudited Condensed Consolidated Financial Statements in Item 1.
 
All amounts in this report, except for share, par values, bushels, gallons, pounds, mmbtu, proof gallons, per share, per bushel, per gallon, per proof gallon and percentage amounts, are shown in thousands unless otherwise noted.


2


PART I. FINANCIAL INFORMATION 

ITEM 1. FINANCIAL STATEMENTS

MGP INGREDIENTS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)
(Dollars in thousands, except per share amounts)
 
 
Quarter Ended
 
Year to Date Ended
 
 
June 30,
2018
 
June 30,
2017
 
June 30,
2018
 
June 30,
2017
Net sales
 
$
88,252

 
$
85,753

 
$
176,208

 
$
172,922

Cost of sales (a)
 
68,811

 
66,928

 
137,816

 
135,056

Gross profit
 
19,441

 
18,825

 
38,392

 
37,866

Selling, general and administrative expenses ("SG&A")
 
8,309

 
8,311

 
16,871

 
15,960

Operating income
 
11,132

 
10,514

 
21,521

 
21,906

Equity method investment loss (Note 3)
 

 
(819
)
 

 
(348
)
Interest expense, net
 
(289
)
 
(379
)
 
(496
)
 
(710
)
Income before income taxes
 
10,843

 
9,316

 
21,025

 
20,848

Income tax expense (Note 5)
 
3,316

 
2,947

 
4,571

 
5,801

Net income
 
$
7,527

 
$
6,369

 
$
16,454

 
$
15,047

 
 
 
 
 
 
 
 
 
Income attributable to participating securities
 
148

 
183

 
323

 
433

Net income attributable to common shareholders and used in earnings per share ("EPS") calculation (Note 6)
 
$
7,379

 
$
6,186

 
$
16,131

 
$
14,614

 
 
 
 
 
 
 
 
 
Share information:
 
 
 
 
 
 
 
 
Basic and Diluted weighted average common shares
 
16,869,481

 
16,745,679

 
16,856,423

 
16,727,305

 
 
 
 
 
 
 
 
 
Basic and diluted earnings per common share
 
$
0.44

 
$
0.37

 
$
0.96

 
$
0.87

Dividends and dividend equivalents per common share
 
$
0.08

 
$
0.04

 
$
0.16

 
$
0.08

 

(a)
Includes related party purchases of $0 and $9,180 for the quarters ended June 30, 2018 and 2017, respectively. Includes related party purchases of $0 and $18,425 for the year-to-date periods ended June 30, 2018 and 2017, respectively.




















See accompanying notes to unaudited condensed consolidated financial statements

3



MGP INGREDIENTS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(Unaudited)
(Dollars in thousands, except per share amounts)

 
Quarter Ended
 
Year to Date Ended
 
June 30,
2018
 
June 30,
2017
 
June 30,
2018
 
June 30,
2017
Net income
$
7,527

 
$
6,369

 
$
16,454

 
$
15,047

Other comprehensive income (loss), net of tax:
 
 
 
 
 
 
 
Change in post-employment benefits
41

 
(38
)
 
28

 
(77
)
Other, net of tax

 
(2
)
 

 
(4
)
Other comprehensive income (loss)
41

 
(40
)
 
28

 
(81
)
Comprehensive income
$
7,568

 
$
6,329

 
$
16,482

 
$
14,966










































See accompanying notes to unaudited condensed consolidated financial statements

4



       MGP INGREDIENTS, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited)
(Dollars in thousands)
 
 
June 30,
2018
 
December 31,
2017
Current Assets
 
 
 
 
Cash and cash equivalents
 
$
2,280

 
$
3,084

Receivables (less allowance for doubtful accounts: June 30, 2018 - $24; December 31, 2017 - $24)
 
35,758

 
34,347

Inventory
 
106,487

 
93,149

Prepaid expenses
 
2,802

 
2,182

Refundable income taxes
 
1,534

 
1,980

Total current assets
 
148,861

 
134,742

 
 
 
 
 
Property and equipment
 
278,548

 
267,288

Less accumulated depreciation and amortization
 
(169,712
)
 
(164,237
)
Property and equipment, net
 
108,836

 
103,051

Other assets
 
2,458

 
2,535

Total assets
 
$
260,155

 
$
240,328

 
 
 
 
 
Current Liabilities
 
 

 
 

Current maturities of long-term debt
 
$
379

 
$
372

Accounts payable
 
23,333

 
30,037

Accrued expenses
 
7,937

 
11,171

Total current liabilities
 
31,649

 
41,580

 
 
 
 
 
Long-term debt, less current maturities
 
21,225

 
21,407

Revolving credit facility
 
18,857

 
2,775

Deferred credits
 
1,789

 
2,151

Accrued retirement, health and life insurance benefits
 
2,989

 
3,133

Other noncurrent liabilities
 
545

 
540

Deferred income taxes
 
741

 
12

Total liabilities
 
77,795

 
71,598

 
 
 
 
 
Contingencies (Note 7)
 


 


Stockholders’ Equity
 
 

 
 

Capital stock
 
 

 
 

Preferred, 5% non-cumulative; $10 par value; authorized 1,000 shares; issued and outstanding 437 shares
 
4

 
4

Common stock
 
 

 
 

No par value; authorized 40,000,000 shares; issued 18,115,965 shares at June 30, 2018 and December 31, 2017, and 16,847,737 and 16,797,420 shares outstanding at June 30, 2018 and  December 31, 2017, respectively
 
6,715

 
6,715

Additional paid-in capital
 
14,484

 
13,912

Retained earnings
 
180,835

 
167,129

Accumulated other comprehensive loss
 
(283
)
 
(311
)
Treasury stock, at cost
 
 

 
 

Shares of 1,268,228 at June 30, 2018 and 1,318,545 at December 31, 2017
 
(19,395
)
 
(18,719
)
Total stockholders’ equity
 
182,360

 
168,730

Total liabilities and stockholders’ equity
 
$
260,155

 
$
240,328



See accompanying notes to unaudited condensed consolidated financial statements

5



MGP INGREDIENTS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(Dollars in thousands)
 
 
Year to Date Ended
 
 
June 30,
2018
 
June 30,
2017
Cash Flows from Operating Activities
 
 
 
 
Net income
 
$
16,454

 
$
15,047

Adjustments to reconcile net income to net cash provided by operating activities:
 
 

 
 

Depreciation and amortization
 
5,826

 
5,554

Distributions received from equity method investee
 

 
7,131

Deferred income taxes
 
729

 
577

Share-based compensation
 
1,968

 
1,737

Equity method investment loss
 

 
348

Changes in operating assets and liabilities:
 
 

 
 

Receivables, net
 
(1,411
)
 
(8,845
)
Inventory
 
(13,338
)
 
(6,693
)
Prepaid expenses
 
(620
)
 
(1,148
)
Accounts payable
 
(5,106
)
 
(671
)
Accounts payable to affiliate, net
 

 
(168
)
Accrued expenses
 
(3,232
)
 
(934
)
Income taxes payable/refundable
 
446

 
(426
)
Deferred credit
 
(362
)
 
(410
)
Accrued retirement health and life insurance benefits
 
(111
)
 
(256
)
Net cash provided by operating activities
 
1,243

 
10,843

Cash Flows from Investing Activities
 
 

 
 

Additions to plant, property and equipment
 
(13,065
)
 
(9,933
)
Return of equity method investment
 

 
299

Net cash used in investing activities
 
(13,065
)
 
(9,634
)
Cash Flows from Financing Activities
 
 

 
 

Purchase of treasury stock for tax withholding on share-based compensation
 
(2,073
)
 
(1,131
)
Payment of dividends and dividend equivalents
 
(2,750
)
 
(1,376
)
Principal payments on long-term debt
 
(185
)
 
(177
)
Proceeds from credit agreement
 
16,946

 
12,467

Payments on credit agreement
 
(920
)
 
(4,650
)
Net cash provided by financing activities
 
11,018

 
5,133

Increase (decrease) in cash and cash equivalents
 
(804
)
 
6,342

Cash and cash equivalents, beginning of period
 
3,084

 
1,569

Cash and cash equivalents, end of period
 
$
2,280

 
$
7,911










See accompanying notes to unaudited condensed consolidated financial statements

6



MGP INGREDIENTS, INC.
CONDENSED CONSOLIDATED STATEMENT OF
CHANGES IN STOCKHOLDERS’ EQUITY
(Unaudited)
(Dollars in thousands)
 
 
 
Capital
Stock
Preferred
 
Common Stock
 
Additional
Paid-In
Capital
 
Retained
Earnings
 
Accumulated
Other
Comprehensive
Loss
 
Treasury
Stock
 
Total
Balance, December 31, 2017
 
$
4

 
$
6,715

 
$
13,912

 
$
167,129

 
$
(311
)
 
$
(18,719
)
 
$
168,730

Comprehensive income:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Net income
 

 

 

 
16,454

 

 

 
16,454

Other comprehensive income
 

 

 

 

 
28

 

 
28

Dividends and dividend equivalents, net of estimated forfeitures
 

 

 

 
(2,748
)
 

 

 
(2,748
)
Share-based compensation
 

 

 
1,553

 

 

 

 
1,553

Stock shares awarded, forfeited, or vested
 

 

 
(981
)
 

 

 
1,397

 
416

Purchase of treasury stock for tax withholding on share-based compensation
 

 

 

 

 

 
(2,073
)
 
(2,073
)
Balance, June 30, 2018
 
$
4

 
$
6,715

 
$
14,484

 
$
180,835

 
$
(283
)
 
$
(19,395
)
 
$
182,360

 































See accompanying notes to unaudited condensed consolidated financial statements

7



MGP INGREDIENTS, INC.
 
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in thousands, unless otherwise noted)

Note 1.  Accounting Policies and Basis of Presentation

The Company. MGP Ingredients, Inc. ("Company") is a Kansas corporation headquartered in Atchison, Kansas and is a leading producer and supplier of premium distilled spirits and specialty wheat protein and starch food ingredients. Distilled spirits include premium bourbon and rye whiskeys and grain neutral spirits, including vodka and gin. MGP is also a top producer of high quality industrial alcohol for use in both food and non-food applications. The Company’s protein and starch food ingredients provide a host of functional, nutritional, and sensory benefits for a wide range of food products to serve the packaged goods industry. The Company's distillery products are derived from corn and other grains (including rye, barley, wheat, barley malt, and milo), and its ingredient products are derived from wheat flour.  The majority of the Company's sales are made directly or through distributors to manufacturers and processors of finished packaged goods or to bakeries.

Basis of Presentation and Principles of Consolidation. The condensed consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries. All significant intercompany balances and transactions have been eliminated in consolidation. These unaudited condensed consolidated financial statements as of and for the quarter ended June 30, 2018 should be read in conjunction with the consolidated financial statements and notes thereto in the Company’s Annual Report on Form 10-K for the year ended December 31, 2017 filed with the Securities and Exchange Commission ("SEC").  The results of operations for interim periods are not necessarily indicative of the results to be expected for the full year.

In the opinion of management, the accompanying unaudited condensed consolidated financial statements contain all adjustments (consisting of normal and recurring adjustments) necessary to fairly present the results for interim periods in accordance with U.S. generally accepted accounting principles (“GAAP”).  Pursuant to the rules and regulations of the SEC, certain information and note disclosures normally included in the financial statements prepared in accordance with GAAP have been condensed or omitted.

Use of Estimates.  The financial reporting policies of the Company conform to GAAP.  The preparation of condensed consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period.  The application of certain of these policies places demands on management’s judgment, with financial reporting results relying on estimation about the effects of matters that are inherently uncertain.  For all of these policies, management cautions that future events rarely develop as forecast, and estimates routinely require adjustment and may require material adjustment.

Inventory.  Inventory includes finished goods, raw materials in the form of agricultural commodities used in the production process and certain maintenance and repair items.  Bourbon and whiskeys are normally aged in barrels for several years, following industry practice; all barreled bourbon and whiskey is classified as a current asset. The Company includes warehousing, insurance, and other carrying charges applicable to barreled whiskey in inventory costs.

Inventories are stated at lower of cost or net realizable value on the first-in, first-out, or FIFO, method.  Inventory valuations are impacted by constantly changing prices paid for key materials, primarily corn. Inventory consists of the following:
 
 
June 30,
2018
 
December 31,
2017
Finished goods
 
$
17,471

 
$
13,284

Barreled distillate (bourbon and whiskey)
 
73,043

 
65,726

Raw materials
 
5,272

 
3,954

Work in process
 
1,500

 
1,935

Maintenance materials
 
7,510

 
7,256

Other
 
1,691

 
994

Total
 
$
106,487

 
$
93,149



8



Revenue Recognition. As a result of the adoption of Accounting Standards Update ("ASU") No. 2014-09, Revenue from Contracts with Customers and related amendments, collectively "Topic 606," ("ASU 2014-09") on January 1, 2018, the Company has changed its accounting policy for revenue recognition (also see Note 2). Revenue is recognized when control of the promised goods or services, through performance obligations by the Company, is transferred to the customer in an amount that reflects the consideration it expects to be entitled to in exchange for the performance obligations. The term between invoicing and when payment is due is not significant and the period between when the entity transfers the promised good or service to the customer and when the customer pays for that good or service is one year or less.

Excise taxes that are both imposed on and concurrent with a specific revenue-producing transaction, that are collected by the Company from a customer are excluded from revenue. Revenue is recognized for the sale of products at the point in time finished products are delivered to the customer in accordance with shipping terms. This is a faithful depiction of the satisfaction of the performance obligation because, at that point control passes to the customer, the customer has legal title and the risk and rewards of ownership have transferred, and the customer has present obligation to pay.

The Company’s distillery products segment routinely enters into bill and hold arrangements, whereby the Company produces and sells unaged distillate to customers, and the product is subsequently barreled at the customer’s request and warehoused at a Company location for an extended period of time in accordance with directions received from the Company’s customers. Even though the unaged distillate remains in the Company's possession, a sale is recognized at the point in time when the customer obtains control of the product. Control is transferred to the customer in bill and hold transactions when: customer acceptance specifications have been met, legal title has transferred, the customer has a present obligation to pay for the product, the risk and rewards of ownership have transferred to the customer, and all the following additional bill and hold criteria have been met: the customer has requested the product be warehoused, the product has been identified as separately belonging to the customer, the product is currently ready for physical transfer to the customer, and the Company does not have the ability to use the product or direct it to another customer.

Warehouse service revenue is recognized over the time that warehouse services are rendered and as they are rendered. This is a faithful depiction of the satisfaction of the performance obligation because control of the aging products has already passed to the customer and there are no additional performance activities required by the Company, except as requested by the customer. The performance of the service activities, as requested, is invoiced as satisfied and revenue is concurrently recognized.

Income Taxes. The Company accounts for income taxes using an asset and liability method which requires the recognition of deferred tax assets and liabilities for the expected future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax basis.

EPS.  Basic and diluted EPS are computed using the two-class method, which is an earnings allocation formula that determines net income per share for each class of Common Stock and participating security according to dividends declared and participation rights in undistributed earnings.  Per share amounts are computed by dividing net income attributable to common shareholders by the weighted average shares outstanding during the period.

Fair Value of Financial Instruments.  The Company determines the fair values of its financial instruments based on a fair value hierarchy, which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The hierarchy is broken down into three levels based upon the observability of inputs. Fair values determined by Level 1 inputs utilize quoted prices (unadjusted) in active markets for identical assets or liabilities that the Company has the ability to access. Level 2 inputs include quoted prices for similar assets and liabilities in active markets and inputs other than quoted prices that are observable for the asset or liability. Level 3 inputs are unobservable inputs for the asset or liability, and include situations where there is little, if any, market activity for the asset or liability. In certain cases, the inputs used to measure fair value may fall into different levels of the fair value hierarchy. In such cases, the level in the fair value hierarchy within which the fair value measurement in its entirety falls has been determined based on the lowest level input that is significant to the fair value measurement in its entirety. The Company’s assessment of the significance of a particular input to the fair value in its entirety requires judgment and considers factors specific to the asset or liability.
 
The Company’s short term financial instruments include cash and cash equivalents, accounts receivable and accounts payable.  The carrying value of the short term financial instruments approximates the fair value due to their short term nature. These financial instruments have no stated maturities or the financial instruments have short term maturities that approximate market.
 

9



The fair value of the Company’s debt is estimated based on current market interest rates for debt with similar maturities and credit quality. The fair value of the Company’s debt was $40,465 and $24,838 at June 30, 2018 and December 31, 2017, respectively. The financial statement carrying value of total debt was $40,461 (including unamortized loan fees) and $24,554 (including unamortized loan fees) at June 30, 2018 and December 31, 2017, respectively.  These fair values are considered Level 2 under the fair value hierarchy.

Recently Issued Accounting Pronouncements. In June 2018, the FASB issued ASU 2018-07, Improvements to Nonemployee Share-Based Payment Accounting, which more closely aligns the accounting for employee and nonemployee share-based payments. This ASU is effective for public business entities for annual and interim periods in fiscal years beginning after December 15, 2018. For all other entities, the amendments are effective for annual periods in fiscal years beginning after December 15, 2019, and interim periods in fiscal years beginning after December 15, 2020. Early adoption is permitted, but no earlier than an entity’s adoption date. The Company is evaluating the effect that ASU 2018-07 will have on its consolidated financial statements and related disclosures.

In February 2018, the FASB issued ASU 2018-02, Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income, which allows a reclassification from accumulated other comprehensive income to retained earnings for stranded tax effects resulting from the Tax Cuts and Jobs Act. This ASU is effective for all entities for annual and interim periods in fiscal years beginning after December 15, 2018. Early adoption is permitted, including adoption in any interim period, (1) for public business entities for reporting periods for which financial statements have not yet been issued and (2) for all other entities for reporting periods for which financial statements have not yet been made available for issuance. The Company is evaluating the effect that ASU 2018-02 will have on its consolidated financial statements and related disclosures.

In January 2018, the FASB issued ASU 2018-01, Land Easement Practical Expedient for Transition to Topic 842, which clarifies that land easements are in the scope of ASU 2016-02, Leases, and provides transition relief. The effective date and transition requirements of ASU 2018-01 are the same as the effective date and transition requirements of ASU 2016-02 (see below). The Company is evaluating the effect that ASU 2018-01 will have on its consolidated financial statements and related disclosures in conjunction with ASU 2016-02.

In February 2016, the FASB issued ASU 2016-02, Leases, which aims to make leasing activities more transparent and comparable and requires substantially all leases be recognized by lessees on their balance sheet as a liability for lease payments and a right-of-use asset for its right to use the underlying asset during the lease term. This ASU is effective for public business entities for interim and annual reporting periods beginning after December 15, 2018. Although early adoption is permitted, the Company is not planning to early adopt the new standard, which replaces existing lease accounting guidance.  The Company can elect to adopt ASC 2016-02 using a modified retrospective transition method requiring application for leases existing at, or entered into after, the beginning of the earliest comparative period presented in the financial statements, with certain practical expedients available. Alternatively, the Company can choose to use its effective date as the date of initial application. The Company is evaluating the effect that the new lease guidance will have on its consolidated financial statements and related disclosures.

Recently Adopted Accounting Standard Updates. In March 2017, the FASB issued ASU 2017-07, Compensation-Retirement Benefits (Topic 715): Improving the Presentation of Net Periodic Pension Cost and Net Periodic Postretirement Benefit Cost, which requires companies to present the service cost component of net benefit cost in the same line items in which they report compensation cost. Companies will present all other components of net benefit cost outside operating income, if this subtotal is presented. This ASU was effective for public business entities for annual and interim periods in fiscal years beginning after December 15, 2017. The Company adopted ASU 2017-07 on January 1, 2018, with immaterial impact on its financial results and presentation for the quarter and year-to-date periods ended June 30, 2018.

In November 2016, the FASB issued ASU 2016-18, Statement of Cash Flows (Topic 230): Restricted Cash, which requires companies to include cash and cash equivalents that have restrictions on withdrawal or use in total cash and cash equivalents on the statement of cash flows. This ASU is effective for public business entities for annual and interim periods in fiscal years beginning after December 15, 2017. The Company adopted ASU 2016-18 on January 1, 2018, and has determined that there is no impact to the presentation of the condensed consolidated statements of cash flows because the Company had no restricted cash for the quarter and year-to-date periods ended June 30, 2018 and 2017.


10



In August 2016, the FASB issued ASU 2016-15, Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments, which addresses eight classification issues related to the statement of cash flows: Debt prepayment or debt extinguishment costs; Settlement of zero coupon bonds; Contingent consideration payments made after a business combination; Proceeds from the settlement of insurance claims; Proceeds from the settlement of corporate owned life insurance policies, including bank owned life insurance policies; Distributions received from equity method investees; Beneficial interests in securitization transactions; and Separately identifiable cash flows and application of the predominance principle. This ASU was effective for public business entities for annual and interim periods in fiscal years beginning after December 15, 2017. The Company adopted ASU 2016-15 on January 1, 2018, and has determined that there is no impact to the presentation of the condensed consolidated statements of cash flows for the quarter and year-to-date periods ended June 30, 2018 and 2017.
    
Note 2.  Revenue

Adoption of Topic 606, Revenue from Contracts with Customers

On January 1, 2018, the Company adopted ASU 2014-09 using the modified retrospective method applied to those contracts which were not completed as of January 1, 2018. Financial results for reporting periods beginning after January 1, 2018 are presented under Topic 606, while prior period amounts are not adjusted and continue to be reported in accordance with the Company's historic accounting under Accounting Standards Codification 605, Revenue Recognition ("ASC 605"). The Company has completed its evaluation of the impact of ASU 2014-09 and concluded that there is no impact to the financial statements as a result of its adoption. The Company recorded no adjustment to opening retained earnings as of January 1, 2018 related to the transition from ASC 605 to ASU 2014-09 and there are no differences to disclose to reconcile financial statement activity as reported under ASU 2014-09 to ASC 605 for the quarter and year to date ended June 30, 2018.

Disaggregation of Revenue.

The following table presents the Company's revenues disaggregated by segment and major products and services.
 
NET SALES
 
NET SALES
 
 
Quarter Ended June 30,
 
Year to Date Ended June 30,
 
 
2018
 
2017(a)
 
2018
 
2017(a)
 
Distillery Products
 
 
 
 
 
 
 
 
Premium beverage alcohol
$
42,200

 
$
42,287

 
$
86,271

 
$
87,926

 
Industrial alcohol
19,295

 
19,342

 
38,639

 
38,465

 
Food grade alcohol
$
61,495

 
$
61,629

 
$
124,910

 
$
126,391

 
Fuel grade alcohol
1,567

 
1,767

 
3,430

 
3,409

 
Distillers feed and related co-products
6,663

 
4,732

 
12,887

 
9,654

 
Warehouse services
2,927

 
2,571

 
5,802

 
5,194

 
Total distillery products
$
72,652

 
$
70,699

 
$
147,029

 
$
144,648

 
 
 
 
 
 
 
 
 
 
Ingredient Solutions
 
 
 
 
 
 
 
 
Specialty wheat starches
$
7,339

 
$
7,411

 
$
14,140

 
$
13,818

 
Specialty wheat proteins
6,008

 
5,224

 
10,744

 
9,603

 
Commodity wheat starch
2,090

 
2,266

 
4,132

 
4,354

 
Commodity wheat protein
163

 
153

 
163

 
499

 
Total ingredient solutions
$
15,600

 
$
15,054

 
$
29,179

 
$
28,274

 
 
 
 
 
 
 
 
 
 
Total net sales
$
88,252

 
$
85,753

 
$
176,208

 
$
172,922

 

(a) As noted above, prior period amounts were not adjusted upon adoption of Topic 606.


11



The following table presents the Company's revenues disaggregated by segment and timing of revenue recognition.
 
NET SALES
 
NET SALES
 
 
Quarter Ended June 30,
 
Year to Date Ended June 30,
 
 
2018
 
2017(a)
 
2018
 
2017(a)
 
Distillery Products
 
 
 
 
 
 
 
 
Products transferred at a point in time
$
69,725

 
$
68,128

 
$
141,227

 
$
139,454

 
Services transferred over time
2,927

 
2,571

 
5,802

 
5,194

 
Total distillery products
$
72,652

 
$
70,699

 
$
147,029

 
$
144,648

 
 
 
 
 
 
 
 
 
 
Ingredient Solutions
 
 
 
 
 
 
 
 
Products transferred at a point in time
$
15,600

 
$
15,054

 
$
29,179

 
$
28,274

 
 
 
 
 
 
 
 
 
 
Total net sales
$
88,252

 
$
85,753

 
$
176,208

 
$
172,922

 

(a) As noted above, prior period amounts were not adjusted upon adoption of Topic 606.

The Company generates revenues from the distillery products segment by the sale of products and by providing warehouse services related to the storage and aging of customer products. The Company generates revenues from the ingredient solutions segment by the sale of products.

Contracts with customers in both segments include a single performance obligation (either the sale of products or the provision of warehouse services). Certain customers may receive volume rebates or discounts, which are accounted for as variable consideration. The Company estimates these amounts based on the expected amount to be provided to customers and reduces revenues recognized. The Company believes there will be no significant changes to the estimates of variable consideration.

Note 3.  Equity Method Investments

As of June 30, 2018, the Company had no investments accounted for using the equity method of accounting. Until July 3, 2017, the Company had a 30 percent interest in Illinois Corn Processing ("ICP"), which manufactured alcohol for fuel, industrial and beverage applications. The Company completed the sale of its equity ownership interest in ICP to Pacific Ethanol Central, LLC, on July 3, 2017, consistent with an Agreement and Plan of Merger entered into on June 26, 2017.

Summary Financial Information (unaudited). Condensed financial information related to the Company’s non-consolidated equity method investment in ICP for the quarter and year to date ended June 30, 2017 is shown below.
 
 
Quarter Ended June 30,
 
Year to Date Ended June 30,
 
 
2017
 
2017
ICP’s Operating results:
 
 
 
 
Net sales (a)
 
$
39,677

 
$
78,062

Cost of sales and expenses (b)
 
42,410

 
79,224

Net loss
 
$
(2,733
)
 
$
(1,162
)

(a) 
Includes related party sales to MGPI for the quarter and year to date ended June 30, 2017 of $9,015 and $17,672, respectively.
(b) 
Includes depreciation and amortization for the quarter and year to date ended June 30, 2017of $862 and $1,720, respectively.

The Company’s equity method investment losses for the quarter and year to date ended June 30, 2017, based on unaudited financial statements, were $819 and $348, respectively.


12



Note 4.  Corporate Borrowings

Indebtedness Outstanding:
Description(a)
June 30,
2018
 
December 31,
2017
Credit Agreement - Revolver, 3.473% (variable rate) due 2022
$
19,324

 
$
3,298

Secured Promissory Note, 3.71% (variable rate) due 2022
1,782

 
1,966

Prudential Note Purchase Agreement, 3.53% (fixed rate) due 2027
20,000

 
20,000

Unamortized loan fees(b)
(645
)
 
(710
)
Total indebtedness outstanding
$
40,461

 
$
24,554

Less current maturities of long term debt
(379
)
 
(372
)
Long-term debt
$
40,082

 
$
24,182


(a) Interest rates are as of June 30, 2018.
(b) Loan fees are being amortized over the life of the Credit Agreement and Note Purchase Agreement.

Credit Agreements. On August 23, 2017, the Company entered into a credit agreement (the “Credit Agreement”) with Wells Fargo Bank, National Association. The Credit Agreement provides for a $150,000 revolving credit facility. The Company may increase the facility from time to time by an aggregate principal amount of up to $25,000 provided certain conditions are satisfied and at the discretion of the lender. The Credit Agreement matures on August 23, 2022. The Credit Agreement includes certain requirements and covenants, which the Company was in compliance with at June 30, 2018. As of June 30, 2018, the Company's total outstanding borrowings under the Credit Agreement were $19,324 leaving $130,676 available.
 
On August 23, 2017, the Company also entered into a Note Purchase and Private Shelf Agreement (the “Note Purchase Agreement”) with PGIM, Inc., an affiliate of Prudential Financial, Inc., and certain affiliates of PGIM, Inc. The Note Purchase Agreement provides for the issuance of up to $75,000 of Senior Secured Notes, and the Company issued $20,000 of Senior Secured Notes with a maturity date of August 23, 2027. The Note Purchase Agreement includes certain requirements and covenants, which the Company was in compliance with at June 30, 2018.

Note 5. Income Taxes
On December 22, 2017, the United States enacted tax reform legislation commonly known as the Tax Cuts and Jobs Act (the “Tax Act”), resulting in significant modifications to U.S. tax law. In December 2017, the SEC staff issued Staff Accounting Bulletin No. 118 (“SAB 118”), which provides guidance on accounting for the tax effects of the Tax Act. SAB 118 provides a measurement period that should not extend beyond one year from the Tax Act enactment date for companies to complete the accounting under ASC 740. As of June 30, 2018, we have not made a measurement period adjustment and the accounting for the Tax Act remains incomplete.

Income tax expense for the quarter and year to date ended June 30, 2018 was $3,316 and $4,571, respectively, for an effective tax rate for the quarter of 30.6 percent and for the year to date of 21.7 percent. For the quarter, the effective tax rate differs from the 21 percent federal statutory rate (as lowered by the Tax Act) on pretax income, primarily due to an increased income tax impact related to the 2017 sale of the Company's equity method investment and a net increase in state taxes. Year to date, the effective tax rate differs from the 21 percent federal statutory rate (as lowered by the Tax Act) on pretax income, primarily due to an increased income tax impact related to the 2017 sale of the Company’s equity method investment and a net increase in state taxes, partially offset by the impact of income tax benefits related to share-based compensation as accounted for in ASU 2016-09, Compensation - Stock Compensation (Topic 718) Improvements to Employee Share-Based Payment Accounting (“ASU 2016-09”).

Income tax expense for the quarter and year to date ended June 30, 2017 was $2,947 and $5,801, respectively, for an effective tax rate for the quarter of 31.6 percent and for the year to date of 27.8 percent. The effective tax rate differed from the 35 percent federal statutory rate on pretax income, primarily due to the impact of income tax benefits related to share-based compensation as accounted for in ASU 2016-09, which was adopted by the Company during the quarter ended September 30, 2016, the domestic production activities deduction, and state taxes, including state income tax credits in Indiana and Kansas.


13



Note 6.  EPS

The computations of basic and diluted EPS for the quarters ended June 30, 2018 and 2017 are as follows:
 
 
Quarter Ended
 
Year to Date Ended
 
 
June 30,
2018
 
June 30,
2017
 
June 30,
2018
 
June 30,
2017
Operations:
 
 
 
 
 
 
 
 
Net income(a)
 
$
7,527

 
$
6,369

 
$
16,454

 
$
15,047

Income attributable to participating securities(b)
 
148

 
183

 
323

 
433

Net income attributable to common shareholders
 
$
7,379

 
$
6,186

 
$
16,131

 
$
14,614

 
 
 
 
 
 
 
 
 
Share information:
 
 
 
 
 
 
 
 
Basic and diluted weighted average common shares(c)
 
16,869,481

 
16,745,679

 
16,856,423

 
16,727,305

 
 
 
 
 
 
 
 
 
Basic and diluted EPS
 
$
0.44

 
$
0.37

 
$
0.96

 
$
0.87

 
 
 
 
 
 
 
 
 
(a) 
Net income attributable to all shareholders.
(b) 
At June 30, 2018 and 2017, participating securities included 338,375 and 497,492 unvested restricted stock units ("RSUs"), respectively.
(c) 
Under the two-class method, weighted average common shares at June 30, 2018 and 2017, exclude unvested, participating securities.

Note 7.  Contingencies

There are various legal and regulatory proceedings involving the Company and its subsidiaries.  The Company accrues estimated costs for a contingency when management believes that a loss is probable and can be reasonably estimated.
 
A chemical release occurred at the Company's Atchison facility on October 21, 2016, which resulted in emissions venting into the air.  The Company reported the event to the Environmental Protection Agency ("EPA"), the Occupational, Safety, and Health Administration ("OSHA"), and to Kansas and local authorities on that date, and is cooperating fully to investigate and ensure that all appropriate response actions are taken.  The Company has also engaged outside experts to assist the investigation and response.  The Company believes it is probable that a fine or penalty may be imposed by regulatory authorities, but it is currently unable to reasonably estimate the amount thereof since some investigations are not complete and could take several months up to a few years to complete.  Private plaintiffs have initiated, and additional private plaintiffs may initiate, legal proceedings for damages resulting from the emission, but the Company is currently unable to reasonably estimate the amount of any such damages that might result.  The Company's insurance is expected to provide coverage of any damages to private plaintiffs, subject to a deductible of $250, but certain regulatory fines or penalties may not be covered and there can be no assurance to the amount or timing of possible insurance recoveries if ultimately claimed by the Company.  There was no significant damage to the Company's Atchison plant as a result of this incident.  No other MGP facilities, including the distillery in Lawrenceburg, Indiana, were affected by this incident.

OSHA completed its investigation and, on April 19, 2017, issued its penalty to the Company in the amount of $138.  Management settled this assessment with OSHA in full for $75, which was paid on May 16, 2017. A portion, or all, of the penalty amount may be covered by insurance.

The EPA informed the Company on August 1, 2017, that it intends to seek civil penalties of approximately $250 in connection with its investigation, while offering the Company the opportunity to settle the matter prior to the EPA proceeding with a formal enforcement action. The Company is seeking a negotiated settlement with the EPA, but negotiations have paused pending resolution of the EPA's criminal investigation. Since the Company expects a negotiated resolution of the EPA civil case and EPA-proposed civil penalties are not material to the quarter and year to date ended June 30, 2018, the Company has not included an accrual in its results. A portion, or all, of the settled penalty amount may be covered by insurance.


14



Note 8.  Employee and Non-Employee Benefit Plans

Equity-Based Compensation Plans.  The Company’s equity-based compensation plans provide for the awarding of stock options, stock appreciation rights, shares of restricted stock ("Restricted Stock"), and RSUs for senior executives and salaried employees, as well as non-employee directors. The Company has two active equity-based compensation plans: the Employee Equity Incentive Plan of 2014 (the "2014 Plan") and the Non-Employee Director Equity Incentive Plan (the "Directors' Plan"). The 2014 Plan replaced the inactive Stock Incentive Plan of 2004.

As of June 30, 2018, 322,221 RSUs had been granted of the 1,500,000 shares approved under the 2014 Plan. 68,934 shares had been granted of the 300,000 shares approved under the Directors' Plan. As of June 30, 2018, 341,295 unvested RSUs were outstanding under the Company’s long-term incentive plans.

Note 9.  Operating Segments

At June 30, 2018 and 2017, the Company had two segments: distillery products and ingredient solutions. The distillery products segment consists of food grade alcohol and distillery co-products, such as distillers feed (commonly called dried distillers grain in the industry) and fuel grade alcohol. The distillery products segment also includes warehouse services, including barrel put away, storage, retrieval, and blending services. Ingredient solutions consists of specialty starches and proteins and commodity starches and proteins.

Operating profit for each segment is based on net sales less identifiable operating expenses.  Non-direct SG&A, interest expense, earnings from the Company's equity method investments until sold on July 3, 2017, other special charges, and other general miscellaneous expenses are excluded from segment operations and are classified as Corporate.  Receivables, inventories, and equipment have been identified with the segments to which they relate.  All other assets are considered as Corporate.
 
 
Quarter Ended
 
Year to Date Ended
 
 
June 30,
2018
 
June 30,
2017
 
June 30,
2018
 
June 30,
2017
Net Sales to Customers
 
 
 
 
 
 
 
 
Distillery products
 
$
72,652

 
$
70,699

 
$
147,029

 
$
144,648

Ingredient solutions
 
15,600

 
15,054

 
29,179

 
28,274

Total
 
88,252

 
85,753

 
176,208

 
172,922

Gross Profit
 
 
 
 
 
 
 
 
Distillery products
 
16,680

 
15,953

 
32,550

 
32,568

Ingredient solutions
 
2,761

 
2,872

 
5,842

 
5,298

Total
 
19,441

 
18,825

 
38,392

 
37,866

Depreciation and Amortization
 
 
 
 
 


 
 
Distillery products
 
2,257

 
2,125

 
4,498

 
4,171

Ingredient solutions
 
379

 
416

 
813

 
824

Corporate
 
261

 
275

 
515

 
559

Total
 
2,897

 
2,816

 
5,826

 
5,554

Income (loss) before Income Taxes 
 
 
 
 
 
 
 
 
Distillery products
 
14,777

 
14,131

 
28,954

 
29,649

Ingredient solutions
 
2,142

 
2,269

 
4,566

 
4,074

Corporate
 
(6,076
)
 
(7,084
)
 
(12,495
)
 
(12,875
)
Total
 
$
10,843

 
$
9,316

 
$
21,025

 
$
20,848


15




The following table allocates assets to each segment:
 
 
As of June 30, 2018
 
As of December 31, 2017
Identifiable Assets
 
 
 
 
Distillery products
 
$
206,184

 
$
191,321

Ingredient solutions
 
35,202

 
28,950

Corporate
 
18,769

 
20,057

Total
 
$
260,155

 
$
240,328


Note 10.  Subsequent Events

On July 31, 2018, the Board of Directors declared a quarterly dividend payable to stockholders of record as of August 16, 2018, of the Company's Common Stock, and a dividend equivalent payable to holders of certain RSUs as of August 16, 2018, of $.08 per share and per unit, payable on August 31, 2018.


16


ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
(Dollar amounts in thousands, unless otherwise noted)

CAUTIONARY NOTE CONCERNING FACTORS THAT MAY AFFECT FUTURE RESULTS

This Report on Form 10-Q contains forward looking statements as well as historical information.  All statements, other than statements of historical facts, regarding the prospects of our industry and our prospects, plans, financial position, and strategic plan may constitute forward looking statements.  In addition, forward looking statements are usually identified by or are associated with such words as "intend," "plan," "believe," "estimate," "expect," "anticipate," "hopeful," "should," "may," "will," "could," "encouraged," "opportunities," "potential," and/or the negatives or variations of these terms or similar terminology.  Forward looking statements are based on current expectations and assumptions that are subject to risks and uncertainties which may cause actual results to differ materially from those expressed or implied in the forward looking statements. A detailed discussion of risks and uncertainties that could cause actual results and events to differ materially from such forward looking statements is included in the section titled "Risk Factors" (Item 1A) of our Annual Report on Form 10-K for the year ended December 31, 2017. Forward looking statements are made as of the date of this report, and we undertake no obligation to update or revise publicly any forward looking statements, whether because of new information, future events or otherwise.

OVERVIEW

MGP is a leading producer and supplier of premium distilled spirits and specialty wheat protein and starch food ingredients. Distilled spirits include premium bourbon and rye whiskeys and grain neutral spirits ("GNS"), including vodka and gin. We are also a top producer of high quality industrial alcohol for use in both food and non-food applications. Our protein and starch food ingredients provide a host of functional, nutritional and sensory benefits for a wide range of food products to serve the packaged goods industry. We have two reportable segments: our distillery products segment and our ingredient solutions segment.

The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our unaudited condensed consolidated financial statements and accompanying notes included in this Form 10-Q, as well as our audited consolidated financial statements and accompanying notes and Management’s Discussion and Analysis of Financial Condition and Results of Operations - General, set forth in our Annual Report on Form 10-K for the year ended December 31, 2017.


17



RESULTS OF OPERATIONS

Consolidated results

The table below details the consolidated results for quarters ended June 30, 2018 and 2017:
 
Quarter Ended June 30,
 
 
 
2018
 
2017
 
2018 v. 2017
 
Net sales
$
88,252

 
$
85,753

 
2.9
 %
 
Cost of sales
68,811

 
66,928

 
2.8

 
Gross profit
19,441

 
18,825

 
3.3

 
   Gross margin %
22.0
%
 
22.0
%
 

pp(a)
Selling, general, and administrative ("SG&A") expenses
8,309

 
8,311

 

 
Operating income
11,132

 
10,514

 
5.9

 
   Operating margin %
12.6
%
 
12.3
%
 
0.3

pp
Equity method investment loss

 
(819
)
 
(100.0
)
 
Interest expense, net
(289
)
 
(379
)
 
(23.7
)
 
Income before income taxes
10,843

 
9,316

 
16.4

 
Income tax expense
3,316

 
2,947

 
12.5

 
   Effective tax expense rate %
30.6
%
 
31.6
%
 
(1.0
)
pp
Net income
$
7,527

 
$
6,369

 
18.2
 %
 
   Net income margin %
8.5
%
 
7.4
%
 
1.1

pp

(a) Percentage points ("pp").

Net sales - Net sales for quarter ended June 30, 2018 were $88,252, an increase of 2.9 percent compared to the year-ago quarter, which was the result of increased net sales in both segments. Within the distillery segment, net sales were up 2.8 percent, primarily due to increases in the net sales of distillers feed and related co-products and warehouse services. Within the ingredient solutions segment, net sales were up 3.6 percent. Net sales of specialty wheat proteins increased, while net sales of commodity and specialty wheat starches declined and net sales of commodity wheat proteins were flat (see Segment Results below).

Gross profit - Gross profit for quarter ended June 30, 2018 was $19,441, an increase of 3.3 percent compared to the year-ago quarter. The increase was driven by an increase in gross profit in the distillery products segment, partially offset by a decrease in gross profit in the ingredient solutions segment. In the distillery products segment, gross profit increased by $727, or 4.6 percent. In the ingredient solutions segment, gross profit declined by $111, or 3.9 percent (see Segment Results below).

SG&A expenses - SG&A expenses for quarter ended June 30, 2018 were $8,309 and remained flat compared to the year-ago quarter. Increases in personnel costs primarily to support the brands platform and other personnel costs were offset by a savings in professional fees.

18



Operating income - Operating income for quarter ended June 30, 2018 increased to $11,132 from $10,514 for quarter ended June 30, 2017, primarily due to the increase in gross profit in our distillery products segment, partially offset by a decrease in gross profit in our ingredient solutions segment.
Operating income, quarter versus quarter
 
Operating Income
 
 Change
 
Operating income for the quarter ended June 30, 2017
 
$
10,514

 
 
 
Increase in gross profit - distillery products segment(a)
 
727

 
6.9

pp(b)
Decrease in gross profit - ingredient solutions segment(a)
 
(111
)
 
(1.0
)
pp
SG&A expenses
 
2

 

pp
Operating income for the quarter ended June 30, 2018
 
$
11,132

 
5.9
 %
 

(a) See segment discussion.
(b) Percentage points ("pp").

Equity method investment - We had no equity method investment earnings for quarter ended June 30, 2018, compared to an equity method investment loss of $819 for quarter ended June 30, 2017. The change in equity method investment earnings was due to the sale of our ICP equity method investment on July 3, 2017, to Pacific Ethanol Central, LLC (see Note 3).

Income tax expense - Income tax expense for quarter ended June 30, 2018 was $3,316, for an effective tax rate of 30.6 percent. Income tax expense for the quarter ended June 30, 2017 was $2,947, for an effective tax rate of 31.6 percent. The primary reasons for the 1.0 percentage point decline in our effective tax rate, quarter versus quarter, are the decrease resulting from implementation of the Tax Cuts and Jobs Act (the “Tax Act”), partially offset by a change in income tax impact related to the sale of our ICP equity method investment.

Earnings per share ("EPS") - EPS was $0.44 for quarter ended June 30, 2018 compared to $0.37 for quarter ended June 30, 2017. EPS increased, quarter versus quarter, primarily due to a net increase in operations from our segments, a decline in equity method investment loss from the sale of our ICP equity method investment, and the decline in our effective tax rate described above.
Change in basic and diluted EPS, quarter versus quarter
 
Basic and Diluted EPS
 
Change
 
Basic and diluted EPS for the quarter ended June 30, 2017
 
$
0.37

 
 
 
Change in operations(a)
 
0.03

 
8.1

pp(b)
Change in equity method investment loss(a)
 
0.03

 
8.1

pp
Tax: Change in effective tax rate
 
0.01

 
2.7

pp
Basic and diluted EPS for the quarter ended June 30, 2018
 
$
0.44

 
18.9
%
 

(a) 
Items are net of tax based on the effective tax rate for the base year (2017).
(b) 
Percentage points ("pp").











19



Consolidated results

The table below details the consolidated results for year to date ended June 30, 2018 and 2017:
 
Year to Date Ended June 30,
 
 
 
2018
 
2017
 
2018 v. 2017
 
Net sales
$
176,208

 
$
172,922

 
1.9
 %
 
Cost of sales
137,816

 
135,056

 
2.0

 
Gross profit
38,392

 
37,866

 
1.4

 
   Gross margin %
21.8
%
 
21.9
%
 
(0.1
)
pp(a)
SG&A expenses
16,871

 
15,960

 
5.7

 
Operating income
21,521

 
21,906

 
(1.8
)
 
   Operating margin %
12.2
%
 
12.7
%
 
(0.5
)
pp
Equity method investment loss

 
(348
)
 
(100.0
)
 
Interest expense, net
(496
)
 
(710
)
 
(30.1
)
 
Income before income taxes
21,025

 
20,848

 
0.8

 
Income tax expense
4,571

 
5,801

 
(21.2
)
 
   Effective tax expense rate %
21.7
%
 
27.8
%
 
(6.1
)
pp
Net income
$
16,454

 
$
15,047

 
9.4
 %
 
   Net income margin %
9.3
%
 
8.7
%
 
0.6

pp

(a) Percentage points ("pp").

Net sales - Net sales for year to date June 30, 2018 were $176,208, an increase of 1.9 percent compared to the year-ago period, which was the result of increased net sales in both segments. Within the distillery segment, net sales were up 1.6 percent. Increases in the net sales of distillers feed and related co-products and warehouse services more than offset a decline in the net sales of food grade alcohol, resulting in the increase for the overall segment, period versus period. Net sales of premium beverage alcohol products within food grade alcohol decreased 1.9 percent, while industrial alcohol product net sales increased 0.5 percent, resulting in a food grade alcohol net sales decrease. Within the ingredient solutions segment, net sales were up 3.2 percent. Net sales of specialty wheat proteins and starches increased, while net sales of commodity wheat proteins and starches declined (see Segment Results below).

Gross profit - Gross profit for year to date June 30, 2018 was $38,392, an increase of 1.4 percent compared to the year-ago period. The increase was driven by an increase in gross profit in the ingredient solutions segment, partially offset by a slight decrease in gross profit in the distillery products segment. In the ingredient solutions segment, gross profit increased by $544, or 10.3 percent (see Segment Results below). In the distillery products segment, gross profit declined by $18, or 0.1 percent.

SG&A expenses - SG&A expenses for year to date June 30, 2018 were $16,871, an increase of 5.7 percent compared to the year-ago period. The increase in SG&A was primarily due to investments in our brands platform (personnel costs and advertising and promotion) and other personnel costs, partially offset by a savings in professional fees.

20



Operating income - Operating income for year to date June 30, 2018 decreased to $21,521 from $21,906 for the period ended June 30, 2017, due to the increase in SG&A expenses described above and a gross profit decline in our distillery products segment, partially offset by an increase in gross profit in our ingredient solutions segment.
Operating income, year to date versus year to date
 
Operating Income
 
 Change
 
Operating income for year to date ended June 30, 2017
 
$
21,906

 
 
 
Decrease in gross profit - distillery products segment(a)
 
(18
)
 
(0.1
)
pp(b)
Increase in gross profit - ingredient solutions segment(a)
 
544

 
2.5

pp
Increase in SG&A expenses
 
(911
)
 
(4.2
)
pp
Operating income for year to date ended June 30, 2018
 
$
21,521

 
(1.8
)%
 

(a) See segment discussion.
(b) Percentage points ("pp").

Equity method investment - We had no equity method investment earnings for year to date June 30, 2018, compared to an equity method investment loss of $348 for the period ended June 30, 2017. The change in equity method investment earnings was due to the sale of our ICP equity method investment on July 3, 2017, to Pacific Ethanol Central, LLC (see Note 3).

Income tax expense - Income tax expense for year to date June 30, 2018 was $4,571, for an effective tax rate of 21.7 percent. Income tax expense for year to date June 30, 2017 was $5,801, for an effective tax rate of 27.8 percent. The primary reasons for the 6.1 percentage point decline in our effective tax rate, period versus period, are the decrease resulting from implementation of the Tax Act, partially offset by a change in income tax impact related to the sale of our ICP equity method investment.

Earnings per share ("EPS") - EPS was $0.96 for year to date June 30, 2018 compared to $0.87 for the period ended June 30, 2017. EPS increased, year to date versus year to date, primarily due to the decline in our effective tax rate described above, a decline in equity method investment loss due to the sale of our ICP equity method investment, a decrease in interest expense, net, and the net effect of the tax benefit on vested share-based compensation. Increases to EPS were partially offset by a net decrease in operations.
Change in basic and diluted EPS, year to date versus year to date
 
Basic and Diluted EPS
 
Change
 
Basic and diluted EPS for year to date ended June 30, 2017
 
$
0.87

 
 
 
Change in operations(a)
 
(0.02
)
 
(2.3
)
pp(b)
Change in equity method investment loss(a)
 
0.01

 
1.2

pp
Change in interest expense, net(a)
 
0.01

 
1.2

pp
Tax: Net effect of the tax benefit on vested share-based compensation
 
0.01

 
1.2

pp
Tax: Change in effective tax rate (excluding tax item above)
 
0.08

 
9.1

pp
Basic and diluted EPS for year to date ended June 30, 2018
 
$
0.96

 
10.4
 %
 

(a) 
Items are net of tax based on the effective tax rate for the base year (2017), excluding the effect of the tax benefit on vested share-based compensation on the 2017 rate.
(b) 
Percentage points ("pp").








21



SEGMENT RESULTS

Distillery Products

The following table shows selected financial information for our distillery products segment for quarters ended June 30, 2018 and 2017.
 
PRODUCT GROUP NET SALES
 
 
Quarter Ended June 30,
 
Quarter versus Quarter Net Sales Change Increase / (Decrease)
 
Quarter versus Quarter Volume Increase / (Decrease)
 
 
2018
 
2017
 
$ Change
 
% Change
 
% Change
 
 
Amount
 
Amount
 
 
 
 
Premium beverage alcohol
$
42,200

 
$
42,287

 
$
(87
)
 
(0.2
)%
 
 
 
Industrial alcohol
19,295

 
19,342

 
(47
)
 
(0.2
)
 
 
 
Food grade alcohol(a)
61,495

 
61,629

 
(134
)
 
(0.2
)
 
 
 
Fuel grade alcohol(a)
1,567

 
1,767

 
(200
)
 
(11.3
)
 
 
 
Distillers feed and related co-products
6,663

 
4,732

 
1,931

 
40.8

 
 
 
Warehouse services
2,927

 
2,571

 
356

 
13.8

 
 
 
Total distillery products
$
72,652

 
$
70,699

 
$
1,953

 
2.8
 %
 
(1.9
)%
(a) 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Other Financial Information
 
 
 
 
Quarter Ended June 30,
 
Quarter versus Quarter Increase / (Decrease)
 
 
 
 
2018
 
2017
 
$ Change
 
% Change
 
 
 
 
 
 
 
 
 
 
Gross profit
$
16,680

 
$
15,953

 
$
727

 
4.6
 %
 
 
 
Gross margin %
23.0
%
 
22.6
%
 


 
0.4

pp(b)
 
 

(a) Volume change for alcohol products.
(b) Percentage points ("pp").

Total net sales of distillery products increased $1,953, or 2.8 percent. Increases in the net sales of distillers feed and related co-products and warehouse services of 40.8 percent and 13.8 percent, respectively, over the year-ago quarter more than offset declines in the net sales of fuel grade alcohol and food grade alcohol. Net sales of premium beverage alcohol and industrial alcohol products within food grade alcohol declined slightly, resulting in a modest food grade alcohol net sales decrease. The increase in net sales of distillers feed and related co-products was due to a higher average selling price reflecting improved market conditions during the quarter.
Gross profit increased quarter versus quarter by $727, or 4.6 percent. Gross margin for the quarter ended June 30, 2018 increased to 23.0 percent from 22.6 percent for the prior-year quarter. The increase in gross profit was primarily due to an increase in gross profit for distillers feed and related co-products and premium beverage alcohol, partially offset by a decline in industrial alcohol gross margins and profits.



22



Distillery Products

The following table shows selected financial information for our distillery products segment for year to date ended June 30, 2018 and 2017.
 
PRODUCT GROUP NET SALES
 
 
Year to Date Ended June 30,
 
Year to Date versus Year to Date Net Sales Change Increase / (Decrease)
 
Year-to-Date versus Year to Date Volume Increase / (Decrease)
 
 
2018
 
2017
 
$ Change
 
% Change
 
% Change
 
 
Amount
 
Amount
 
 
 
 
Premium beverage alcohol
$
86,271

 
$
87,926

 
$
(1,655
)
 
(1.9
)%
 
 
 
Industrial alcohol
38,639

 
38,465

 
174

 
0.5

 
 
 
Food grade alcohol(a)
124,910

 
126,391

 
(1,481
)
 
(1.2
)
 
 
 
Fuel grade alcohol(a)
3,430

 
3,409

 
21

 
0.6

 
 
 
Distillers feed and related co-products
12,887

 
9,654

 
3,233

 
33.5

 
 
 
Warehouse services
5,802

 
5,194

 
608

 
11.7

 
 
 
Total distillery products
$
147,029

 
$
144,648

 
$
2,381

 
1.6
 %
 
0.4
%
(a) 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Other Financial Information
 
 
 
 
Year to Date Ended June 30,
 
Year to Date versus Year to Date Increase / (Decrease)
 
 
 
 
2018
 
2017
 
$ Change
 
% Change
 
 
 
 
 
 
 
 
 
 
Gross profit
$
32,550

 
$
32,568

 
$
(18
)
 
(0.1
)%
 
 
 
Gross margin %
22.1
%
 
22.5
%
 
 
 
(0.4
)
pp(b)
 
 

(a) Volume change for alcohol products.
(b) Percentage points ("pp").

Total net sales of distillery products increased $2,381, or 1.6 percent. Increases in the net sales of distillers feed and related co-products, warehouse services, and fuel grade alcohol of 33.5 percent, 11.7 percent, and 0.6 percent, respectively, over the prior-year period more than offset a decline in the net sales of food grade alcohol. Net sales of premium beverage alcohol products within food grade alcohol decreased 1.9 percent, while industrial alcohol product net sales increased 0.5 percent, resulting in a food grade alcohol net sales decrease. The increase in net sales of distillers feed and related co-products was due to a higher average selling price reflecting improved market conditions during the period. The decline in net sales of premium beverage alcohol was primarily due to reduced volume related to the timing of customer orders and related shipments during the period.
Gross profit decreased year to date versus year to date by $18, or 0.1 percent. Gross margin for year to date June 30, 2018 decreased to 22.1 percent from 22.5 percent for the prior-year period. The decline in gross profit was primarily due to lower gross margins and profits on industrial alcohol, offset by an increase in distillers feed and related co-products gross profit.








23



Ingredient Solutions

The following table shows selected financial information for our ingredient solutions segment for quarters ended June 30, 2018 and 2017.
 
PRODUCT GROUP NET SALES
 
Quarter Ended June 30,
 
Quarter versus Quarter Net Sales Change Increase / (Decrease)
 
Quarter versus Quarter Volume Increase / (Decrease)
 
2018
 
2017
 
$ Change
 
% Change
 
% Change
 
Amount
 
Amount
 
 
 
Specialty wheat starches
$
7,339

 
$
7,411

 
$
(72
)
 
(1.0
)%
 


Specialty wheat proteins
6,008

 
5,224

 
784

 
15.0

 


Commodity wheat starches
2,090

 
2,266

 
(176
)
 
(7.8
)
 
 
Commodity wheat proteins
163

 
153

 
10

 
6.5

 
 
Total ingredient solutions
$
15,600

 
$
15,054

 
$
546

 
3.6
 %
 
(6.0
)%
 
 
 
 
 
 
 
 
 
 
 
Other Financial Information
 
 
 
Quarter Ended June 30,
 
Quarter versus Quarter Increase / (Decrease)
 
 
 
2018
 
2017
 
$ Change
 
% Change
 
 
 
 
 
 
 
 
Gross profit
$
2,761

 
$
2,872

 
$
(111
)
 
(3.9
)%
 
 
Gross margin %
17.7
%
 
19.1
%
 


 
(1.4
)
pp(a)
 

(a) Percentage points ("pp").

Total ingredient solutions net sales for quarter ended June 30, 2018 increased by $546, or 3.6 percent, compared to the prior-year quarter. This increase was primarily driven by increased net sales of specialty wheat proteins, partially offset by decreased net sales of commodity and specialty wheat starches, quarter versus quarter.
Gross profit decreased quarter versus quarter by $111, or 3.9 percent. Gross margin for the quarter ended June 30, 2018 decreased to 17.7 percent from 19.1 percent for the prior year quarter. The decrease in gross profit was primarily due to an increase in input costs.





24



Ingredient Solutions

The following table shows selected financial information for our ingredient solutions segment for year to date ended June 30, 2018 and 2017.
 
PRODUCT GROUP NET SALES
 
Year to Date Ended June 30,
 
Year to Date versus Year to Date Net Sales Change Increase / (Decrease)
 
Year to Date versus Year to Date Volume Increase / (Decrease)
 
2018
 
2017
 
$ Change
 
% Change
 
% Change
 
Amount
 
Amount
 
 
 
Specialty wheat starches
$
14,140

 
$
13,818

 
$
322

 
2.3
 %
 
 
Specialty wheat proteins
10,744

 
9,603

 
1,141

 
11.9

 
 
Commodity wheat starches
4,132

 
4,354

 
(222
)
 
(5.1
)
 
 
Commodity wheat proteins
163

 
499

 
(336
)
 
(67.3
)
 
 
Total ingredient solutions
$
29,179

 
$
28,274

 
$
905

 
3.2
 %
 
(6.2
)%
 
 
 
 
 
 
 
 
 
 
 
Other Financial Information
 
 
 
Year to Date Ended June 30,
 
Year to Date versus Year to Date Increase / (Decrease)
 
 
 
2018
 
2017
 
$ Change
 
% Change
 
 
 
 
 
 
 
 
Gross profit
$
5,842

 
$
5,298

 
$
544

 
10.3
 %
 
 
Gross margin %
20.0
%
 
18.7
%
 
 
 
1.3

pp(a)
 

(a) Percentage points ("pp").

Total ingredient solutions net sales for year to date ended June 30, 2018 increased by $905, or 3.2 percent, compared to the prior-year period. This increase was primarily driven by increased net sales of specialty wheat proteins and starches, partially offset by decreased net sales of commodity wheat proteins and starches, period versus period. The year to date net sales decline of commodity wheat proteins and starches reflects our shift to higher margin specialty wheat proteins and starches.
Gross profit increased period versus period by $544, or 10.3 percent. Gross margin for year to date ended June 30, 2018 increased to 20.0 percent from 18.7 percent for the prior-year period. The increase in gross profit was primarily due to the shift to higher margin products and a higher average selling price, partially offset by an increase in input costs.


















25



CASH FLOW, FINANCIAL CONDITION AND LIQUIDITY

We believe our financial condition continues to be of high quality, as evidenced by our ability to generate adequate cash from operations while having ready access to capital at competitive rates.

Operating cash flow and debt through our Credit Agreement and Note Purchase Agreement (Note 4) provide the primary sources of cash to fund operating needs and capital expenditures. These same sources of cash are used to fund shareholder dividends and other discretionary uses. Going forward, we expect to use cash to implement our invest to grow strategy, particularly in the distillery products segment. Our overall liquidity reflects our strong business results and an effective cash management strategy that takes into account liquidity management, economic factors, and tax considerations. We expect our sources of cash, including our Credit Agreement and Note Purchase Agreement, to be adequate to provide for budgeted capital expenditures and anticipated operating requirements for the foreseeable future.

Cash Flow Summary


 
Year to Date Ended
 
 
 
 
June 30,
2018
 
June 30,
2017
 
Changes, Year to Date versus Year to Date
Cash provided by operating activities:
 
 
 
 
 
 
Net income, after giving effect to adjustments to reconcile net income to net cash provided by operating activities
 
$
24,977

 
$
30,394

 
$
(5,417
)
Receivables, net
 
(1,411
)
 
(8,845
)
 
7,434

Inventory
 
(13,338
)
 
(6,693
)
 
(6,645
)
Accrued expenses
 
(3,232
)
 
(934
)
 
(2,298
)
Income taxes payable/refundable
 
446

 
(426
)
 
872

Accounts payable and accounts payable to affiliate, net
 
(5,106
)
 
(839
)
 
(4,267
)
Other, net
 
(1,093
)
 
(1,814
)
 
721

Total
 
$
1,243

 
$
10,843

 
$
(9,600
)
Cash used in investing activities:
 
 
 
 
 
 
Additions to property, plant, and equipment
 
(13,065
)
 
(9,933
)
 
(3,132
)
Other
 

 
299

 
(299
)
Total
 
$
(13,065
)
 
$
(9,634
)
 
$
(3,431
)
Cash provided by financing activities: