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, 2022. 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, branded spirits and food ingredients. Distilled spirits include premium bourbon, rye, and other whiskeys (“brown goods”) and grain neutral spirits (“GNS”), including vodka and gin. Our distilled spirits are either sold directly or indirectly to manufacturers of other branded spirits. MGP is also a producer of high quality industrial alcohol for use in both food and non-food applications. The Company has a portfolio of our own high quality branded spirits, which we produce through our distilleries and bottling facilities and sell to distributors. Our branded spirits products account for a range of price points from value products through ultra premium brands, with a focus on high-end American whiskey, tequila and gin. The Company’s protein and starch food ingredients serve a host of functional, nutritional, and sensory benefits for a wide range of food products to serve the consumer packaged goods industry. Our ingredients products are sold directly, or through distributors, to manufacturers and processors of finished packaged goods or to bakeries. 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 Report, 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, 2022. 17 RESULTS OF OPERATIONS Consolidated Results The table below details the consolidated results for the quarters ended March 31, 2023 and 2022: Quarter Ended March 31, 2023 2022 2023 v. 2022 Sales $ 201,010 $ 195,235 3 % Cost of sales 131,186 123,414 6 Gross profit 69,824 71,821 (3) Gross margin % 34.7 % 36.8 % (2.1) pp (a) Advertising and promotion expenses 7,733 5,504 41 Selling, general, and administrative (“SG&A”) expenses 20,532 16,237 26 Operating income 41,559 50,080 (17) Operating margin % 20.7 % 25.7 % (5.0) pp Interest expense, net (995) (1,598) 38 Other income (expense), net 123 54 128 Income before income taxes 40,687 48,536 (16) Income tax expense 9,655 11,165 (14) Effective tax expense rate % 23.7 % 23.0 % 0.7 pp Net income $ 31,032 $ 37,371 (17) % Net income margin % 15.4 % 19.1 % (3.7) pp (a) Percentage points (“pp”). Sales - Sales for the quarter ended March 31, 2023 were $201,010, an increase of 3 percent compared to the year-ago quarter, which was the result of increased sales in the Ingredient Solutions, Distilling Solutions, and Branded Spirits segments. Within the Ingredient Solutions segment, sales were up 10 percent, primarily due to increased sales of specialty wheat proteins. Within the Distilling Solutions segment, sales were up 2 percent, primarily due to an increase in the sales of brown goods within premium beverage alcohol. Within the Branded Spirits segment, sales were up 2 percent, primarily due to increased sales of brands in the value and mid price tiers (see Segment Results). Gross profit - Gross profit for the quarter ended March 31, 2023 was $69,824, a decrease of 3 percent compared to the year-ago quarter. The decrease was driven by a decrease in gross profit in the Distilling Solutions and Branded Spirits segments, partially offset by an increase in gross profit in the Ingredient Solutions segment. Within the Distilling Solutions segment, gross profit declined by $5,905, or 15 percent. Within the Branded Spirits segment, gross profit was in line with the year-ago quarter, slightly decreasing by $189, or 1 percent. Within the Ingredient Solutions segment, gross profit increased by $4,097, or 51 percent (see Segment Results). Advertising and promotion expenses - Advertising and promotion expenses for the quarter ended March 31, 2023 were $7,733, an increase of 41 percent compared to the year-ago quarter, primarily driven by increased advertising and promotion investment in the Branded Spirits segment, specifically in the premium plus price tiers. SG&A expenses - SG&A expenses for the quarter ended March 31, 2023 were $20,532, an increase of 26 percent compared to the year-ago quarter, primarily due to higher personnel expense. 18 Operating income - Operating income for the quarter ended March 31, 2023 decreased to $41,559 from $50,080 for the quarter ended March 31, 2022, primarily due to a decrease in gross profit in the Distilling Solutions and Branded Spirits segments as well as an increase in the previously described advertising and promotion and SG&A expenses. These decreases were partially offset by an increase in gross profit in the Ingredient Solutions segment. Operating income, quarter versus quarter Operating Income Change Operating income for the quarter ended March 31, 2022 $ 50,080 Decrease in gross profit - Distilling Solutions segment (a) (5,905) (12) % pp (b) Decrease in gross profit - Branded Spirits segment (a) (189) — pp Increase in gross profit - Ingredient Solutions segment (a) 4,097 8 pp Increase in advertising and promotion expenses (2,229) (4) pp Increase in SG&A expenses (4,295) (9) pp Operating income for the quarter ended March 31, 2023 $ 41,559 (17) % (a) See segment discussion. (b) Percentage points (“pp”). Income tax expense - Income tax expense for the quarter ended March 31, 2023 was $9,655, for an effective tax rate of 23.7 percent. Income tax expense for the quarter ended March 31, 2022 was $11,165, for an effective tax rate of 23.0 percent. The decrease in income tax expense, quarter versus quarter, was due primarily to lower income before income taxes. The increase in effective tax rate, quarter versus quarter, was due primarily to lower state tax credits. Earnings per common share (“EPS”) - Basic EPS was $1.40 for the quarter ended March 31, 2023, compared to $1.69 for the quarter ended March 31, 2022. The change in Basic EPS, quarter versus quarter, was primarily due to a decrease in operating income. Diluted EPS was $1.39 for the quarter ended March 31, 2023, compared to $1.69 for the quarter ended March 31, 2022. The change in Diluted EPS, quarter versus quarter, was primarily due to the same changes as Basic EPS as well as the impact of dilutive shares outstanding related to the conversion feature of the Convertible Senior Notes. Change in basic and diluted EPS, quarter versus quarter Basic and Diluted EPS Change Basic and diluted EPS for the quarter ended March 31, 2022 $ 1.69 Change in operating income (a) (0.30) (18) % pp (b) Change in interest expense, net (a) 0.02 1 pp Change in weighted average shares outstanding (0.01) (1) pp Basic EPS for the quarter ended March 31, 2023 $ 1.40 (18) % Impact of dilutive shares outstanding (0.01) (1) pp Diluted EPS for the quarter ended March 31, 2023 $ 1.39 (19) % (a) Item is net of tax based on the effective tax rate for the base year (2022). (b) Percentage points (“pp”). 19 SEGMENT RESULTS Distilling Solutions The following tables show selected financial information for the Distilling Solutions segment for the quarters ended March 31, 2023 and 2022. DISTILLING SOLUTIONS SALES Quarter Ended March 31, Quarter versus Quarter Sales Change Increase/(Decrease) 2023 2022 $ Change % Change Brown goods $ 68,324 $ 62,145 $ 6,179 10 % White goods 15,954 20,086 (4,132) (21) Premium beverage alcohol 84,278 82,231 2,047 2 Industrial alcohol 10,439 11,495 (1,056) (9) Food grade alcohol 94,717 93,726 991 1 Fuel grade alcohol 2,556 3,282 (726) (22) Distillers feed and related co-products 9,092 8,917 175 2 Warehouse services 6,858 5,584 1,274 23 Total Distilling Solutions $ 113,223 $ 111,509 $ 1,714 2 % Change in Quarter versus Quarter Sales Attributed to: Total (a) Volume (b) Net Price/Mix (c) Premium beverage alcohol 2% (17)% 19% Other Financial Information Quarter Ended March 31, Quarter versus Quarter Increase / (Decrease) 2023 2022 $ Change % Change Gross profit $ 33,028 $ 38,933 $ (5,905) (15) % Gross margin % 29.2 % 34.9 % (5.7) 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. The product is then divided by prior period sales dollars. (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. The product is then divided by prior period sales dollars. (d) Percentage points (“pp”). Total sales of the Distilling Solutions segment for the quarter ended March 31, 2023 increased by $1,714, or 2 percent, compared to the prior year quarter. Sales of brown goods within premium beverage alcohol, warehouse services, and distillers feed and related co-products increased while white goods within premium beverage alcohol, industrial alcohol, and fuel grade alcohol decreased. The increase in sales of brown goods was driven by a higher average selling price, partially offset by lower sales volume. This increase was partially offset by a decrease in sales of white goods and industrial alcohol, which was driven primarily by lower sales volume, partially offset by a higher average selling price. Gross profit decreased quarter versus quarter by $5,905, or 15 percent. Gross margin for the quarter ended March 31, 2023 decreased to 29.2 percent from 34.9 percent for the prior year quarter. The decrease in gross profit was primarily due to higher input costs and lower sales volume for brown goods, as well as higher input costs for white goods and industrial alcohol. The average selling price for these products also increased, but not enough to offset the higher input costs and lower sales volumes. 20 Branded Spirits The following tables show selected financial information for the Branded Spirits segment for the quarters ended March 31, 2023 and 2022. BRANDED SPIRITS SALES Quarter Ended March 31, Quarter versus Quarter Sales Change Increase/(Decrease) 2023 2022 $ Change % Change Ultra premium $ 9,115 $ 12,597 $ (3,482) (28) % Super premium 2,847 2,946 (99) (3) Premium 6,784 6,140 644 10 Premium plus 18,746 21,683 (2,937) (14) Mid 20,835 19,273 1,562 8 Value 13,421 11,299 2,122 19 Other 3,881 3,496 385 11 Total Branded Spirits $ 56,883 $ 55,751 $ 1,132 2 % Change in Quarter versus Quarter Sales Attributed to: Total (a) Volume (b) Net Price/Mix (c) Total Branded Spirits 2% 8% (6)% Other Financial Information Quarter Ended March 31, Quarter versus Quarter Increase / (Decrease) 2023 2022 $ Change % Change Gross profit $ 24,593 $ 24,782 $ (189) (1) % Gross margin % 43.2 % 44.5 % (1.3) 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. The product is then divided by prior period sales dollars. (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. The product is then divided by prior period sales dollars. (d) Percentage points (“pp”). Total sales of the Branded Spirits segment for the quarter ended March 31, 2023 increased by $1,132, or 2 percent compared to the prior year quarter. Sales increased primarily due to an increase in sales of brands within the value and mid price tiers primarily due to a distributor realignment which resulted in increased sales volume in these price tiers. These increases were partially offset by a decrease in the ultra premium price tier primarily due to timing of sales of our American whiskey brands. Gross profit decreased quarter versus quarter by $189, or 1 percent. Gross margin for the quarter ended March 31, 2023 decreased to 43.2 percent from 44.5 percent for the prior year quarter. The decrease in gross profit was primarily driven by a decrease in sales volume in the ultra premium price tier due to the timing of sales of our American whiskey brands, partially offset by increased sales price and volume of brands within the mid and value price tiers. 21 Ingredient Solutions The following tables show selected financial information for the Ingredient Solutions segment for the quarters ended March 31, 2023 and 2022. INGREDIENT SOLUTIONS SALES Quarter Ended March 31, Quarter versus Quarter Sales Change Increase / (Decrease) 2023 2022 $ Change % Change Specialty wheat starches $ 14,686 $ 15,203 $ (517) (3) % Specialty wheat proteins 11,890 9,419 2,471 26 Commodity wheat starches 3,807 3,353 454 14 Commodity wheat proteins 521 — 521 N/A Total Ingredient Solutions $ 30,904 $ 27,975 $ 2,929 10 % Change in Quarter versus Quarter Sales Attributed to: Total (a) Volume (b) Net Price/Mix (c) Total Ingredient Solutions 10% (12)% 22% Other Financial Information Quarter Ended March 31, Quarter versus Quarter Increase / (Decrease) 2023 2022 $ Change % Change Gross profit $ 12,203 $ 8,106 $ 4,097 51 % Gross margin % 39.5 % 29.0 % 10.5 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. The product is then divided by prior period sales dollars. (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. The product is then divided by prior period sales dollars. (d) Percentage points (“pp”). Total sales of the Ingredient Solutions segment for the quarter ended March 31, 2023 increased by $2,929, or 10 percent, compared to the prior year quarter. The increase was primarily driven by higher sales of specialty wheat proteins, commodity wheat proteins and commodity wheat starches due to higher average selling prices. These increases were partially offset by a decrease in specialty wheat starches due primarily to lower sales volume, partially offset by higher average selling prices. Gross profit increased quarter versus quarter by $4,097, or 51 percent. Gross margin for the quarter ended March 31, 2023 increased to 39.5 percent from 29.0 percent for the prior year quarter. The increase in gross profit was primarily driven by higher average selling price across all product categories, partially offset by higher input costs for specialty wheat starches and proteins. 22 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 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. 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 mergers or acquisitions, and anticipated operating requirements for the foreseeable future. Cash Flow Summary Quarter to Date Ended March 31, Changes, year versus year Increase / (Decrease) 2023 2022 Cash provided by operating activities $ 5,021 $ 22,230 $ (17,209) Cash used in investing activities (16,945) (12,033) (4,912) Cash used in financing activities (4,270) (4,182) (88) Effect of exchange rate changes on cash 33 (288) 321 Increase (decrease) in cash and cash equivalents $ (16,161) $ 5,727 $ (21,888) Cash decreased $16,161 for the quarter ended March 31, 2023, compared to an increase of $5,727 for the quarter ended March 31, 2022, for a net decrease in cash of $21,888, period versus period. Operating Activities. Cash provided by operating activities for the quarter ended March 31, 2023 was $5,021. The cash provided by operating activities resulted primarily from net income of $31,032, adjustments for non-cash or non-operating charges of $7,318, including depreciation and amortization, and share-based compensation, partially offset by cash used in operating assets and liabilities of $33,329. The primary drivers of the changes in operating assets and liabilities were $19,227 use of cash related to increased accounts receivable, net due to timing of sales and customer payments during the quarter, $18,707 use of cash related to an increase in inventories, primarily due to an increase in finished goods inventory and barreled distillate, and $10,208 use of cash related to a decrease in accrued expenses and other, primarily due to the incentive compensation payout during the quarter. These uses of cash were partially offset, primarily by $9,043 cash provided by income taxes payable, and $6,498 cash provided by an increase in accounts payable. Cash provided by operating activities for the 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 to 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. Investing Activities. Cash used in investing activities for the quarter ended March 31, 2023 was $16,945, which primarily resulted from additions to property, plant and equipment of $16,237 (see Capital Spending). Cash used in investing activities for the quarter ended March 31, 2022 was $12,033, which primarily resulted from additions to property, plant and equipment of $10,642 (see Capital Spending). Capital Spending. We manage capital spending to support our business growth plans. We have incurred $9,824 and $5,074 of capital expenditures and have paid $16,237 and $10,642 for capital expenditures for the quarter ended March 31, 2023 and 2022, 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 $58,000 in capital expenditures in 2023, which will be used for facility improvement and expansion, facility sustaining projects, and environmental health and safety projects. 23 Financing Activities. Cash used in financing activities for the quarter ended March 31, 2023 was $4,270, due to payments of dividends and dividend equivalents of $2,669 (see Dividends and Dividend Equivalents), purchases of treasury stock of $801 (see Treasury Purchases), and net payments on debt of $800 (see Long-Term and Short-Term Debt). Cash used in financing activities for the 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). Treasury Purchases. 22,592 RSUs vested and converted to common shares for employees during the quarter ended March 31, 2023, of which we withheld and purchased for treasury 8,437 shares valued at $801 to cover payment of associated withholding taxes. 29,346 RSUs vested and converted to common shares for employees during the 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. Dividends and Dividend Equivalents Dividend and Dividend Equivalent Information (per Share and Unit) Declaration date Record date Payment date Declared (c) Paid (c) Dividend payment Dividend equivalent payment (a)(b) Total payment (b) 2023 February 23, 2023 March 10, 2023 March 24, 2023 $ 0.12 $ 0.12 $ 2,640 $ 29 $ 2,669 2022 February 22, 2022 March 11, 2022 March 25, 2022 $ 0.12 $ 0.12 $ 2,638 $ 23 $ 2,661 (a) Dividend equivalent payments on unvested participating securities. (b) Includes estimated forfeitures. (c) Per share amount On May 4, 2023, our Board of Directors declared a quarterly dividend payable to stockholders of record as of May 19, 2023, of the Company’s Common Stock, resulting in dividend equivalents payable to holders of certain RSUs as of May 19, 2023, of $0.12 per share and per unit, payable on June 2, 2023. 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 $229,619 (net of unamortized loan fees of $6,031) at March 31, 2023, and $230,335 (net of unamortized loan fees of $6,115) at December 31, 2022. 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, 2023, we met those covenants and restrictions. At March 31, 2023, our current assets exceeded our current liabilities by $373,124, largely due to our inventories, at cost, of $308,558. At March 31, 2023, our cash balance was $31,728 and we have used our various debt agreements for liquidity purposes, with $400,000 under our Credit Agreement remaining for additional borrowings and up to $120,000 potentially available under the Note Purchase Agreement. 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. We utilize short-term and long-term debt to fund discretionary items, such as capital investments, dividend payments as well as potential mergers and acquisitions. Subject to market conditions, we could also fund future mergers and acquisitions through the issuance of additional shares of common stock. In addition, we have strong operating results such that we believe financial institutions should provide sufficient credit funding to meet short-term financing requirements, if needed. 24