MGP INGREDIENTS INC 10-Q

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, 2020 and Part II, Item 1A of this report Form 10Q. 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. RECENT DEVELOPMENTS Acquisition of Luxco. On January 22, 2021, we entered into a definitive agreement to acquire Luxco, Inc. and its affiliated companies (“Luxco”, or “Luxco Companies”), and subsequently completed the merger on April 1, 2021. Luxco is a leading branded beverage alcohol company across various categories, with a more than 60-year business heritage. As a result of the acquisition of Luxco, we expect to increase our scale and market position in the branded-spirits sector and strengthen our platform for future growth of higher valued-added products. Following the merger, the Luxco Companies became wholly-owned subsidiaries of MGP. The aggregate consideration we paid in connection with the merger was $237,500 in cash (less assumed indebtedness) and 5,007,833 shares of common stock of the Company valued at $296,213, subject to adjustment for fractional shares. (Note 3, Business Acquisition for additional information). Feed Dryer Fire. During November 2020, we experienced a fire at the Atchison facility. The fire damaged certain equipment in the facility’s feed drying operations and caused temporary loss of production time. During the quarter ended March 31 2021, we recorded a $3,610 partial settlement from our insurance carrier as a reduction of Cost of sales. We are working to construct a replacement drying system. Our insurance is expected to provide coverage of any business interruption and other losses from damage to property, plant and equipment, but there can be no assurance to the amount or timing of possible insurance recoveries if ultimately claimed by the Company. COVID-19. As the COVID-19 pandemic continues, we are monitoring the guidance from federal, state and local public health authorities and will take the necessary actions to comply with the updated guidelines. The Company’s business is part of the United States’ critical infrastructure and thus is deemed to be an “essential business.” As such, we continue to take the necessary and appropriate actions to protect our workforce as it continues its critical operations. We have continued to operate without any significant negative impacts; however this could be effected by voluntary or mandatory temporary closures of our facilities, interruptions to our supply chain or additional efforts to protect the health and safety of our employees. As of the date of this report, the Company’s operations, supply chain and customer demand have not been significantly affected 17 by COVID-19; however, we are monitoring the situation closely. The Company cannot reasonably estimate the length of time or severity of the pandemic and cannot estimate the impact this pandemic will have on our consolidated financial results for 2021. 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. 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, 2020. RESULTS OF OPERATIONS Consolidated results The table below details the consolidated results for the quarters ended March 31, 2021 and 2020: Quarter Ended March 31, 2021 2020 2021 v. 2020 Sales $ 108,323 $ 99,082 9.3 % Cost of sales 76,024 75,871 0.2 Gross profit 32,299 23,211 39.2 Gross margin % 29.8 % 23.4 % 6.4 pp (a) Selling, general, and administrative (“SG&A”) expenses 11,799 9,503 24.2 Operating income 20,500 13,708 49.6 Operating margin % 18.9 % 13.8 % 5.1 pp Interest expense, net and other (458) (642) 28.7 Income before income taxes 20,042 13,066 53.4 Income tax expense 4,615 3,224 43.1 Effective tax expense rate % 23.0 % 24.7 % (1.7) pp Net income $ 15,427 $ 9,842 56.7 % Net income margin % 14.2 % 9.9 % 4.3 pp (a) Percentage points (“pp”). Sales - Sales for quarter ended March 31, 2021 were $108,323, an increase of 9.3 percent compared to the year-ago quarter, which was the result of increased sales in both the Distillery Products and Ingredient Solutions segments. Within the Distillery Products segment, sales were up 11.5 percent, primarily due to an increase in the sales of brown goods within premium beverage alcohol. Within the Ingredient Solutions segment, sales were up 0.3 percent, primarily due to increased sales of commodity wheat starches, partially offset by specialty wheat proteins (see Segment Results). Gross profit - Gross profit for quarter ended March 31, 2021 was $32,299, an increase of 39.2 percent compared to the year-ago quarter. The increase was driven by an increase in gross profit in 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 $10,082, or 55.2 percent. In the Ingredient Solutions segment, gross profit decreased by $994, or 20.0 percent (see Segment Results). SG&A expenses - SG&A expenses for quarter ended March 31, 2021 were $11,799, an increase of 24.2 percent compared to the year-ago quarter. The increase in SG&A was primarily due to Luxco acquisition related costs. 18 Operating income - Operating income for quarter ended March 31, 2021 increased to $20,500 from $13,708 for quarter ended March 31, 2020, primarily due to an increase in gross profit in the Distillery Products segment, partially offset by the increase in the previously described SG&A expenses and decrease in gross profit in the Ingredient Solutions segment. Operating income, quarter versus quarter Operating Income Change Operating income for quarter ended March 31, 2020 $ 13,708 Increase in gross profit - Distillery Products segment (a) 10,082 73.6 pp (b) Decrease in gross profit - Ingredient Solutions segment (a) (994) (7.3) pp Increase in SG&A expenses (2,296) (16.7) pp Operating income for quarter ended March 31, 2021 $ 20,500 49.6 % (a) See segment discussion. (b) Percentage points (“pp”). Income tax expense - Income tax expense for quarter ended March 31, 2021 was $4,615, for an effective tax rate of 23.0 percent. Income tax expense for the quarter ended March 31, 2020, was $3,224, for an effective tax rate of 24.7 percent. The increase in Income tax expense, quarter versus quarter, was primarily due to an increase in Income before income taxes. The effective tax rate decreased, quarter versus quarter, primarily due to additional tax credits recognized as a result of the new drying system investment. Earnings per share (“EPS”) - EPS was $0.90 for quarter ended March 31, 2021, compared to $0.57 for quarter ended March 31, 2020. The change in EPS, quarter versus quarter, was primarily due to an increase in Operating income, and by a change in effective tax rate as previously described. Change in basic and diluted EPS, quarter versus quarter Basic and Diluted EPS Change Basic and diluted EPS for quarter ended March 31, 2020 $ 0.57 Increase in operations (a) 0.30 52.6 pp (b) Tax: Change in effective tax rate 0.02 3.5 pp Decrease in weighted average shares outstanding 0.01 1.8 pp Basic and diluted EPS for quarter ended March 31, 2021 $ 0.90 57.9 % (a) Item is net of tax based on the effective tax rate for the base year (2020). (b) Percentage points (“pp”). 19 SEGMENT RESULTS Distillery Products The following tables show selected financial information for the Distillery Products segment for the quarters ended March 31, 2021 and 2020. DISTILLERY PRODUCTS SALES Quarter Ended March 31, Quarter versus Quarter Sales Change Increase/(Decrease) 2021 2020 $ Change % Change Brown goods $ 43,415 $ 29,070 $ 14,345 49.3 % White goods 16,853 16,902 (49) (0.3) Premium beverage alcohol 60,268 45,972 14,296 31.1 Industrial alcohol 17,336 21,618 (4,282) (19.8) Food grade alcohol 77,604 67,590 10,014 14.8 Fuel grade alcohol 2,517 1,522 995 65.4 Distillers feed and related co-products 4,972 6,989 (2,017) (28.9) Warehouse services 4,101 3,901 200 5.1 Total Distillery Products $ 89,194 $ 80,002 $ 9,192 11.5 % Change in Quarter versus Quarter Sales Attributed to: Total (a) Volume (b) Net Price/Mix (c) Premium beverage alcohol 31.1% 24.7% 6.4% Other Financial Information Quarter Ended March 31, Quarter versus Quarter Increase / (Decrease) 2021 2020 $ Change % Change Gross profit $ 28,331 $ 18,249 $ 10,082 55.2 % Gross margin % 31.8 % 22.8 % 9.0 pp (d) (a) Total sales change is calculated by taking the difference between current period sales dollars and prior period sales dollars, divided by prior period sales dollars. (b) Volume change is calculated by taking the difference between current period sales volume and prior period sales volume, multiplied by prior period sales per unit (c) Price/Mix change is calculated by taking the difference between current period sales-per-unit and prior period sales-per unit, multiplied by current period sales volume. (d) Percentage points (“pp”). Total sales of Distillery Products for the quarter ended March 31, 2021 increased by $9,192, or 11.5 percent, compared to the prior year quarter. Sales of brown goods within premium beverage alcohol, fuel grade alcohol and warehouse services increased while industrial alcohol, distillers feed and related co-products, and white goods within premium beverage alcohol decreased compared to the prior year quarter. The increase in sales of brown goods and fuel grade alcohol was driven by higher sales volume and higher average selling price. These increases were offset by a decrease in sales of industrial alcohol which was driven by lower sales volume due to the discontinuing of the ICP third party sales and marketing services, partially offset by higher average selling price. The decrease in sales of distillers feed and related co-products was due to lower average selling price, partially offset by higher sales volume both of which are results of the Dryer Fire Incident (see Note 8, Commitments and Contingencies for further details). Gross profit increased quarter versus quarter by $10,082, or 55.2 percent. Gross margin for the quarter ended March 31, 2021 increased to 31.8 percent from 22.8 percent for the prior year quarter. The increase in gross profit was primarily due to higher sales volume on brown goods as well as higher average selling price on industrial alcohol. The increase in gross profit was partially offset by higher input costs of brown and white goods. 20 Ingredient Solutions The following tables show selected financial information for the Ingredient Solutions segment for the quarter ended March 31, 2021 and 2020. INGREDIENT SOLUTIONS SALES Quarter Ended March 31, Quarter versus Quarter Sales Change Increase / (Decrease) 2021 2020 $ Change % Change Specialty wheat starches $ 10,222 $ 10,212 $ 10 0.1 % Specialty wheat proteins 6,046 6,365 (319) (5.0) Commodity wheat starches 2,283 1,877 406 21.6 Commodity wheat proteins 578 626 (48) (7.7) Total Ingredient Solutions $ 19,129 $ 19,080 $ 49 0.3 % Change in Quarter versus Quarter Sales Attributed to: Total (a) Volume (b) Net Price/Mix (c) Total Ingredient Solutions 0.3% (0.1)% 0.4% Other Financial Information Quarter Ended March 31, Quarter versus Quarter Increase / (Decrease) 2021 2020 $ Change % Change Gross profit $ 3,968 $ 4,962 $ (994) (20.0) % Gross margin % 20.7 % 26.0 % (5.3) pp (d) (a) Total sales change is calculated by taking the difference between current period sales dollars and prior period sales dollars, divided by prior period sales dollars. (b) Volume change is calculated by taking the difference between current period sales volume and prior period sales volume, multiplied by prior period sales per unit (c) Price/Mix change is calculated by taking the difference between current period sales-per-unit and prior period sales-per unit, multiplied by current period sales volume. (d) Percentage points (“pp”). Total Ingredient Solutions sales for quarter ended March 31, 2021 increased by $49, or 0.3 percent, compared to the prior year quarter. Quarter versus quarter, this increase was driven by higher sales of commodity wheat starches, partially offset by decreased sales of specialty wheat proteins. The increase in sales of commodity wheat starches, which entered the quarter with higher relative inventory, was primarily driven by increased sales volume. These increases were partially offset by decreased sales volume of specialty wheat proteins, partially offset by higher average selling price. Gross profit decreased quarter versus quarter by $994, or 20.0 percent. Gross margin for the quarter ended March 31, 2021 decreased to 20.7 percent from 26.0 percent for the prior year quarter. The decrease in gross profit was primarily driven by the temporary curtailment of natural gas usage due to extreme weather conditions which caused the Company to shut down the Atchison facilities for several days. 21 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 5) 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. 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 Quarter Ended March 31, Changes, quarter versus quarter Increase / (Decrease) 2021 2020 Cash provided by operating activities $ 16,990 $ 542 $ 16,448 Cash used in investing activities (13,340) (8,189) (5,151) Cash (used in) provided by financing activities (2,726) 46,997 (49,723) Increase in cash and cash equivalents $ 924 $ 39,350 $ (38,426) Cash increased $924 for quarter ended March 31, 2021, compared to an increase of $39,350 for quarter ended March 31, 2020, for a net decrease in cash of $38,426, period versus period. Operating Activities. Cash provided by operating activities for quarter ended March 31, 2021 was $16,990. The cash provided by operating activities during quarter ended March 31, 2021 resulted primarily from net income of $15,427, adjustments for non-cash or non-operating charges of $5,892 including, depreciation and amortization, and share-based compensation, partially offset by uses of cash due to changes in operating assets and liabilities of $4,329. The primary drivers of the changes in operating assets and liabilities were $8,385 use of cash related to a decrease in accrued expenses and other primarily related to incentive compensation expenses, $4,348 use of cash related to an increase in accounts receivables, net due to increased sales during the quarter as well as an increase in insurance recoveries receivable, and $1,084 use of cash related to an increase in prepaid expenses due to an increase in prepaid insurance. These uses of cash were partially offset by $5,237 cash provided by an increase in income taxes payable and $4,924 related to a decrease in inventories, primarily barreled distillate. Cash provided by operating activities for quarter ended March 31, 2020 was $542. The cash provided by operating activities during quarter ended March 31, 2020 resulted primarily from net income of $9,842, adjustments for non-cash or non-operating charges of $4,356, including depreciation and amortization and share-based compensation, partially offset by uses of cash due to changes in operating assets and liabilities of $13,656. The primary drivers of the changes in operating assets and liabilities were $11,453 use of cash related to an increase in receivables, net due to timing of customer payments as well as increased sales during the quarter, $5,649 use of cash related to an increase in inventories, primarily barreled distillate, and $2,339 use of cash related to an increase in prepaid expenses. These uses of cash were partially offset by $3,100 cash provided by income taxes payable (refundable) and $1,635 cash provided by accounts payable related to timing of cash disbursements. Investing Activities. Cash used in investing activities for quarter ended March 31, 2021 was $13,340, which resulted from additions to property, plant and equipment of $12,059 (see Capital Spending). Cash used in investing activities for quarter ended March 31, 2020 was $8,189, which resulted from additions to property, plant and equipment of $5,645 (see Capital Spending) and an increase related to the acquisition of a business of $2,750, partially offset by proceeds from sale of property of $366. Capital Spending. We manage capital spending to support our business growth plans. Investments in property, plant and equipment were $12,059 and $5,645 for quarter ended March 31, 2021 and 2020, respectively. Adjusted for the change in capital expenditures in accounts payable for quarter ended March 31, 2021 and 2020, of $(2,238) and $(2,690), respectively, total capital expenditures were $9,821 and $2,955, respectively. 22 We expect approximately $43,300 in capital expenditures in 2021, excluding any insurance recoveries. Of the $43,300 expected capital expenditures $29,400 is allocated for the replacement of the feed dryer system. The remainder is for facility improvement and expansion, facility sustenance projects, and environmental health and safety projects. Financing Activities. Cash used in financing activities for quarter ended March 31, 2021 was $2,726, due to payments of dividends and dividend equivalents of $2,052 (see Dividends and Dividend Equivalents) and purchases of treasury stock of $674 (see Treasury Purchases and Share Repurchases). Cash provided financing activities for quarter ended March 31, 2020 was $46,997, primarily due to net proceeds from debt of $54,600 (See Long-Term and Short-Term Debt), offset by purchases of treasury stock of $4,395 (see Treasury Purchases and Share Repurchases) and payments of dividends and dividend equivalents of $2,060 (see Dividends and Dividend Equivalents). Treasury Purchases. 33,829 RSUs vested and converted to common shares for employees during quarter ended March 31, 2021, of which we withheld and purchased for treasury 10,376 shares valued at $674 to cover payment of associated withholding taxes. 30,388 RSUs vested and converted to common shares for employees during quarter ended March 31, 2020, of which we withheld and purchased for treasury 10,044 shares valued at $342 to cover payment of associated withholding taxes. Share Repurchases. On February 25, 2019, our Board of Directors approved a $25,000 share repurchase authorization commencing February 27, 2019, through February 27, 2022. Under the share repurchase program, we can repurchase stock from time to time for cash in open market purchases, block transactions, and privately negotiated transactions in accordance with applicable federal securities laws. This share repurchase program may be modified, suspended, or terminated by us at any time without prior notice. The Company did not repurchase any shares during the quarter ended March 31, 2021 and has $20,947 remaining under the share repurchase plan. During the quarter ended March 31, 2020, we repurchased approximately 159,104 shares of MGP Common Stock for $4,053. Dividends and Dividend Equivalents Dividend and Dividend Equivalent Information (per Share and Unit) Declaration date Record date Payment date Declared Paid Dividend payment Dividend equivalent payment (a)(b) Total payment (b) 2021 February 23, 2021 March 12, 2021 March 26, 2021 $ 0.12 $ 0.12 $ 2,033 $ 19 $ 2,052 2020 February 24, 2020 March 13, 2020 March 27, 2020 $ 0.12 $ 0.12 $ 2,047 $ 13 $ 2,060 (a) Dividend equivalent payments on unvested participating securities. (b) Includes estimated forfeitures. On May 3, 2021, our Board of Directors declared a quarterly dividend payable to stockholders of record as of May 21, 2021, of the Company’s Common Stock, and a dividend equivalent payable to holders of certain RSUs as of May 21, 2021, of $0.12 per share and per unit, payable on June 4, 2021. Long-Term and Short-Term Debt. We maintain debt levels we consider appropriate after evaluating a number of factors, including cash flow expectations, cash requirements for ongoing operations, investment and financing plans (including brand development and share repurchase activities) and the overall cost of capital. Total debt was $39,876 (net of unamortized loan fees of $124) at March 31, 2021, and $39,871 (net of unamortized loan fees of $129) at December 31, 2020. Financial Condition and Liquidity. Our principal uses of cash in the ordinary course of business are for input costs used in our production processes, salaries, capital expenditures, and investments supporting our strategic plan, such as the aging of barreled distillate. Generally, during periods when commodities prices are rising, our operations require increased use of cash to support inventory levels. 23 Our principal sources of cash are product sales and borrowing on our Credit Agreement and Note Purchase Agreement. Under our Credit Agreement and Note Purchase Agreement, we must meet certain financial covenants and restrictions, and at March 31, 2021, we met those covenants and restrictions. At March 31, 2021, our current assets exceeded our current liabilities by $174,545, largely due to our inventories, at cost, of $136,087. At March 31, 2021, our cash balance was $22,586 and we have used our Credit Agreement and Note Purchase Agreement for liquidity purposes, with $300,000 remaining for additional borrowings. We anticipate being able to support our short-term liquidity and operating needs largely through cash generated from operations. We regularly assess our cash needs and the available sources to fund these needs. While we currently believe we are well positioned with our credit agreement, we will continue to monitor the impact of the COVID-19 pandemic on our operations and liquidity needs. We utilize short-term and long-term debt to fund discretionary items, such as capital investments and dividend payments. In addition, we have strong operating results such that financial institutions should provide sufficient credit funding to meet short-term financing requirements, if needed. On April 1, 2021, the Company completed the merger with Luxco. The aggregate consideration paid by the Company in connection with the merger was $237,500 in cash (less assumed indebtedness) and 5,007,833 shares of common stock of the Company, subject to adjustment for fractional shares (the “Company Shares,” and together with the cash portion, the “Merger Consideration”). The Merger Consideration is subject to customary purchase price adjustments, including working capital, which adjustments are anticipated to be paid in cash. The cash portion of the Merger Consideration, the repayment of assumed debt and transaction-related expenses were financed with a $242,300 borrowing under the Credit Agreement. We anticipate having sufficient cash flows to support our short-term liquidity and operating needs.