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, 2021. 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. 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 designed 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 by COVID-19; however, we are monitoring the situation closely. OVERVIEW MGP is a leading producer and supplier of premium distilled spirits, branded spirits and 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 distilled spirits are either packaged and sold under our own brands to distributors, sold, directly or indirectly, to manufacturers of other branded spirits, or direct to consumer. 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 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, 2021. 20 RESULTS OF OPERATIONS Consolidated Results The table below details the consolidated results for the quarters ended March 31, 2022 and 2021: Quarter Ended March 31, 2022 2021 2022 v. 2021 Sales $ 195,235 $ 108,323 80.2 % Cost of sales 123,414 76,024 62.3 Gross profit 71,821 32,299 122.4 Gross margin % 36.8 % 29.8 % 7.0 pp (a) Advertising and promotion expenses 5,504 853 545.3 Selling, general, and administrative (“SG&A”) expenses 16,266 10,946 48.6 Other operating income, net (29) — N/A Operating income 50,080 20,500 144.3 Operating margin % 25.7 % 18.9 % 6.8 pp Interest expense (1,598) (488) (227.5) Other income, net 54 30 80.0 Income before income taxes 48,536 20,042 142.2 Income tax expense 11,165 4,615 141.9 Effective tax expense rate % 23.0 % 23.0 % — pp Net income $ 37,371 $ 15,427 142.2 % Net income margin % 19.1 % 14.2 % 4.9 pp (a) Percentage points (“pp”). Sales - Sales for quarter ended March 31, 2022 were $195,235, an increase of 80.2 percent compared to the year-ago quarter, which was the result of increased sales in the Branded Spirits, Distilling Solutions, and Ingredient Solutions segments. Within the Branded Spirits segment, sales were up 9,680.9 percent, due to the additional brands acquired as part of the April 1, 2021 merger with Luxco, Inc. (“Luxco”). Within the Distilling Solutions segment, sales were up 25.8 percent, primarily due to an increase in the sales of brown goods within premium beverage alcohol. Within the Ingredient Solutions segment, sales were up 46.2 percent, primarily due to increased sales of specialty wheat starches and proteins (see Segment Results). Gross profit - Gross profit for quarter ended March 31, 2022 was $71,821, an increase of 122.4 percent compared to the year-ago quarter. The increase was driven by an increase in gross profit in Branded Spirits, Distilling Solutions, and Ingredient Solutions segments. In the Branded Spirits segment, gross profit increased by $24,696 or 28,716.3 percent. In the Distilling Solutions segment, gross profit increased by $10,688, or 37.8 percent. In the Ingredient Solutions segment, gross profit increased by $4,138, or 104.3 percent (see Segment Results). Advertising and promotion expenses - Advertising and promotion expenses for quarter ended March 31, 2022 were $5,504, an increase of 545.3 percent compared to the year-ago quarter. The increase in Advertising and promotion expenses was primarily driven by the assumption of Luxco’s Advertising and promotion expenses. SG&A expenses - SG&A expenses for quarter ended March 31, 2022 were $16,266, an increase of 48.6 percent compared to the year-ago quarter. The increase in SG&A expenses was primarily driven by the assumption of Luxco’s SG&A expenses. 21 Operating income - Operating income for quarter ended March 31, 2022 increased to $50,080 from $20,500 for quarter ended March 31, 2021, primarily due to an increase in gross profit in the Branded Spirits, Distilling Solutions and Ingredient Solutions segments, partially offset by the increase in the previously described Advertising and promotion expenses and SG&A expenses. Operating income, quarter versus quarter Operating Income Change Operating income for quarter ended March 31, 2021 $ 20,500 Increase in gross profit - Branded Spirits segment (a) 24,696 120.5 pp (b) Increase in gross profit - Distilling Solutions segment (a) 10,688 52.1 pp Increase in gross profit - Ingredient Solutions segment (a) 4,138 20.2 pp Increase in Advertising and promotion expenses (4,651) (22.7) pp Increase in SG&A expenses (5,320) (26.0) pp Increase in Other operating income, net 29 0.1 pp Operating income for quarter ended March 31, 2022 $ 50,080 144.3 % (a) See segment discussion. (b) Percentage points (“pp”). Income tax expense - Income tax expense for quarter ended March 31, 2022 was $11,165, for an effective tax rate of 23.0 percent. Income tax expense for the quarter ended March 31, 2021, was $4,615, for an effective tax rate of 23.0 percent. The increase in Income tax expense, quarter versus quarter, was due to higher Income before income taxes. Earnings per share (“EPS”) - EPS was $1.69 for quarter ended March 31, 2022, compared to $0.90 for quarter ended March 31, 2021. The change in EPS, quarter versus quarter, was primarily due to an increase in Operating income, partially offset by an increase in shares outstanding. Change in basic and diluted EPS, quarter versus quarter Basic and Diluted EPS Change Basic and diluted EPS for quarter ended March 31, 2021 $ 0.90 Increase in Operating income (a) 1.34 148.9 pp (b) Change in income allocated to participating securities 0.01 1.1 pp Change in interest expense, net (a) (0.05) (5.6) pp Change in weighted average shares outstanding (0.51) (56.7) pp Basic and diluted EPS for quarter ended March 31, 2022 $ 1.69 87.7 % (a) Item is net of tax based on the effective tax rate for the base year (2021). (b) Percentage points (“pp”). 22 SEGMENT RESULTS Distilling Solutions The following tables show selected financial information for the Distilling Solutions segment for the quarters ended March 31, 2022 and 2021. DISTILLING SOLUTIONS SALES Quarter Ended March 31, Quarter versus Quarter Sales Change Increase/(Decrease) 2022 2021 $ Change % Change Brown goods $ 62,145 $ 43,041 $ 19,104 44.4 % White goods 20,086 16,657 3,429 20.6 Premium beverage alcohol 82,231 59,698 22,533 37.7 Industrial alcohol 11,495 17,336 (5,841) (33.7) Food grade alcohol 93,726 77,034 16,692 21.7 Fuel grade alcohol 3,282 2,517 765 30.4 Distillers feed and related co-products 8,917 4,972 3,945 79.3 Warehouse services 5,584 4,101 1,483 36.2 Total Distilling Solutions $ 111,509 $ 88,624 $ 22,885 25.8 % Change in Quarter versus Quarter Sales Attributed to: Total (a) Volume (b) Net Price/Mix (c) Premium beverage alcohol 37.7% 20.5% 17.2% Other Financial Information Quarter Ended March 31, Quarter versus Quarter Increase / (Decrease) 2022 2021 $ Change % Change Gross profit $ 38,933 $ 28,245 $ 10,688 37.8 % Gross margin % 34.9 % 31.9 % 3.0 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 Distilling Solutions for quarter ended March 31, 2022 increased by $22,885, or 25.8 percent, compared to the prior year quarter. Sales of brown goods within premium beverage alcohol, distillers feed and related co-products, white goods within premium beverage alcohol, warehouse services, and fuel grade alcohol increased while industrial alcohol decreased compared to the prior year quarter. The increase in sales of brown goods was driven by higher sales volume and higher average selling price. The increase in sales of distillers feed and related co-products was due to higher average selling price, partially offset by lower sales volumes, both of which primarily resulted from the 2020 Dryer Fire Incident. The increase in sales of white goods and fuel grade alcohol was driven by higher average selling price and higher sales volume. These increases were partially offset by a decrease in sales of industrial alcohol which was driven by lower sales volume due to the discontinuing of ICP third party sales and marketing services, partially offset by higher average selling price. Gross profit increased quarter versus quarter by $10,688, or 37.8 percent. Gross margin for the quarter ended March 31, 2022 increased to 34.9 percent from 31.9 percent for the prior year quarter. The increase in gross profit was primarily due to higher average selling price and higher sales volume on brown goods as well higher average selling price of distillers feed and related co-products and white goods. These increases were partially offset by higher input costs of distillers feed and related co-products, industrial alcohol and white goods. 23 Branded Spirits The following tables show selected financial information for the Branded Spirits segment for the quarters ended March 31, 2022 and 2021. BRANDED SPIRITS SALES Quarter Ended March 31, Quarter versus Quarter Sales Change Increase/(Decrease) 2022 2021 $ Change % Change Ultra premium $ 12,597 $ 126 $ 12,471 9,897.6 % Super premium 2,946 411 2,535 616.8 Premium 6,140 26 6,114 23,515.4 Mid 19,273 — 19,273 N/A Value 11,299 — 11,299 N/A Other 3,496 7 3,489 49,842.9 Total Branded Spirits $ 55,751 $ 570 $ 55,181 9,680.9 % Change in Quarter versus Quarter Sales Attributed to: Total (a) Volume (b) Net Price/Mix (c) Total Branded Spirits 9,680.9% 37,466.2% (27,785.3)% Other Financial Information Quarter Ended March 31, Quarter versus Quarter Increase / (Decrease) 2022 2021 $ Change % Change Gross profit $ 24,782 $ 86 $ 24,696 28,716.3 % Gross margin % 44.5 % 15.1 % 29.4 pp (d) (a) Total sales changes 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 Branded Spirits for quarter ended March 31, 2022 increased by $55,181, or 9,680.9 percent compared to the prior year quarter. Sales across all pricing tiers increased compared to the prior year quarter, primarily due to the additional brands acquired as part of the April 1, 2021 Merger. Gross profit increased quarter versus quarter by $24,696, or 28,716.3 percent. Gross margin for the quarter ended March 31, 2022 increased to 44.5 percent from 15.1 percent for the prior year quarter. The increase in gross profit was primarily due to the additional brands acquired as part of the Merger. 24 Ingredient Solutions The following tables show selected financial information for the Ingredient Solutions segment for the quarters ended March 31, 2022 and 2021. INGREDIENT SOLUTIONS SALES Quarter Ended March 31, Quarter versus Quarter Sales Change Increase / (Decrease) 2022 2021 $ Change % Change Specialty wheat starches $ 15,203 $ 10,222 $ 4,981 48.7 % Specialty wheat proteins 9,419 6,046 3,373 55.9 Commodity wheat starches 3,353 2,283 1,070 46.9 Commodity wheat proteins — 578 (578) N/A Total Ingredient Solutions $ 27,975 $ 19,129 $ 8,846 46.2 % Change in Quarter versus Quarter Sales Attributed to: Total (a) Volume (b) Net Price/Mix (c) Total Ingredient Solutions 46.2% 23.7% 22.5% Other Financial Information Quarter Ended March 31, Quarter versus Quarter Increase / (Decrease) 2022 2021 $ Change % Change Gross profit $ 8,106 $ 3,968 $ 4,138 104.3 % Gross margin % 29.0 % 20.7 % 8.3 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, 2022 increased by $8,846, or 46.2 percent, compared to the prior year quarter. The increase was primarily driven by higher sales of specialty wheat starches and proteins, and commodity wheat starches due to higher sales volume and higher average selling price. These increases were partially offset by a decrease in sales volume of commodity wheat proteins. Gross profit increased quarter versus quarter by $4,138, or 104.3 percent. Gross margin for the quarter ended March 31, 2022 increased to 29.0 percent from 20.7 percent for the prior year quarter. The increase in gross profit was primarily driven by higher average selling price and higher sales volume of specialty wheat proteins and starches and commodity wheat starches, partially offset by higher input costs for specialty wheat starches and commodity starches. Gross profit in the prior year quarter was impacted by a temporary curtailment of natural gas usage due to extreme weather conditions which caused the Company to shut down the Atchison facilities for several days. 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 borrowings through our Credit Agreement, Convertible Senior Notes 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 to be adequate to provide for budgeted capital expenditures, potential merger or acquisitions, and anticipated operating requirements for the foreseeable future. Cash Flow Summary Quarter Ended March 31, Changes, year versus year Increase / (Decrease) 2022 2021 Cash provided by operating activities $ 22,230 $ 16,990 $ 5,240 Cash used in investing activities (12,033) (13,340) 1,307 Cash used in financing activities (4,182) (2,726) (1,456) Effect of exchange rate changes on cash (288) — (288) Increase in cash and cash equivalents $ 5,727 $ 924 $ 4,803 Cash increased $5,727 for quarter ended March 31, 2022, compared to an increase of $924 for quarter ended March 31, 2021, for a net increase in cash of $4,803, period versus period. Operating Activities. Cash provided by operating activities for quarter ended March 31, 2022 was $22,230. The cash provided by operating activities resulted primarily from net income of $37,371, adjustments for non-cash or non-operating charges of $6,971, including depreciation and amortization, and share-based compensation, partially offset by cash used in operating assets and liabilities of $22,112. The primary drivers of the changes in operating assets and liabilities were $13,696 use of cash related to an increase in inventories, primarily barreled distillate, $9,601 use of cash related to increased accounts receivables, net due to increased sales during the quarter, and $8,896 use of cash related accrued expenses and other primarily related to an incentive compensation payout. These uses of cash were partially offset by $5,437 cash provided by an increase in income taxes payable and $4,638 cash provided by accounts payable. Cash provided by operating activities for quarter ended March 31, 2021 was $16,990. The cash provided by operating activities 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 $8,278 use of cash related to a decrease in accrued expenses 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, 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 use of cash related to an increase in inventories, primarily barreled distillate. Investing Activities. Cash used in investing activities for quarter ended March 31, 2022 was $12,033, which primarily resulted from additions to property, plant and equipment of $10,642 (see Capital Spending). Cash used in investing activities for quarter ended March 31, 2021 was $13,340, which primarily resulted from additions to property, plant and equipment of $12,059 (see Capital Spending). 26 Capital Spending. We manage capital spending to support our business growth plans. We have incurred $5,074 and $9,821 of capital expenditures and have paid $10,642 and $12,059 for capital expenditures for quarter ended March 31, 2022 and 2021, respectively. The difference between the amount of capital expenditures incurred and amount paid is due to the change in capital expenditures in accounts payable. We expect approximately $47,200 in capital expenditures in 2022 which will be used 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, 2022 was $4,182, due to payments of dividends and dividend equivalents of $2,661 (see Dividends and Dividend Equivalents), net payments on debt of $807 (see Long-Term and Short-Term Debt) and purchases of treasury stock of $714 (see Treasury Purchases and Share Repurchases). Cash provided by financing activities for quarter ended March 31, 2021 was $2,726, primarily 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). Treasury Purchases. 29,346 RSUs vested and converted to common shares for employees during quarter ended March 31, 2022, of which we withheld and purchased for treasury 9,021 shares valued at $711 to cover payment of associated withholding taxes. 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. 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. The Company did not repurchase any shares during the quarter ended March 31, 2022 and the program expired on February 27, 2022. 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) 2022 February 22, 2022 March 11, 2022 March 25, 2022 $ 0.12 $ 0.12 $ 2,638 $ 23 $ 2,661 2021 February 23, 2021 March 12, 2021 March 26, 2021 $ 0.12 $ 0.12 $ 2,033 $ 19 $ 2,052 (a) Dividend equivalent payments on unvested participating securities. (b) Includes estimated forfeitures. On May 5, 2022, our Board of Directors declared a quarterly dividend payable to stockholders of record as of May 20, 2022, of the Company’s Common Stock, and a dividend equivalent payable to holders of certain RSUs as of May 20, 2022, of $0.12 per share and per unit, payable on June 3, 2022. 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 $232,677 (net of unamortized loan fees of $6,369) at March 31, 2022, and $233,399 (net of unamortized loan fees of $6,454) at December 31, 2021. 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 and potential mergers and acquisitions. Generally, during periods when commodities prices are rising, our operations require increased use of cash to support inventory levels. Our principal sources of cash are product sales and borrowing on our various debt agreements. Under our debt agreements, we must meet certain financial covenants and restrictions, and at March 31, 2022, we met those covenants and restrictions. 27 At March 31, 2022, our current assets exceeded our current liabilities by $310,802, largely due to our inventories, at cost, of $259,517. At March 31, 2022, our cash balance was $27,295 and we have used our Credit Agreement, Convertible Senior Notes and Note Purchase Agreement for liquidity purposes, with $400,000 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.