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PENX > SEC Filings for PENX > Form 10-K on 8-Nov-2012All Recent SEC Filings

Show all filings for PENFORD CORP

Form 10-K for PENFORD CORP


8-Nov-2012

Annual Report


Item 7: Management's Discussion and Analysis of Financial Condition and Results of Operations

This Management's Discussion and Analysis of Financial Condition and Results of Operations ("MD&A") should be read in conjunction with the Company's consolidated financial statements and the accompanying notes. The notes to the Consolidated Financial Statements referred to in this MD&A are included in Part II Item 8, "Financial Statements and Supplementary Data." Unless otherwise noted, all amounts and analyses are based on continuing operations.

Overview

Penford generates revenues, income and cash flows by developing, manufacturing and marketing specialty natural-based ingredient systems for food and industrial applications, including fuel grade ethanol. The Company develops and manufactures ingredients with starch as a base, providing value-added applications to its customers. Penford's starch products are manufactured primarily from corn and potatoes and are used principally as binders and coatings in paper, packaging and food production and as an ingredient in fuel.

Penford manages its business in two segments: Industrial Ingredients and Food Ingredients. These segments are based on broad categories of end-market users. See Note 20 to Consolidated Financial Statements for additional information regarding the Company's business segment operations. In January 2012, the Company acquired, through purchase and lease, the net assets and operations of Carolina Starches, which manufactures and markets industrial potato starch products and blends for the paper and packaging industries. The net assets and results of operations since acquisition have been integrated into the Company's existing business segments. The acquired net assets, consisting primarily of property, plant and equipment and working capital, are being managed by and included in the reported balance sheet amounts of the Company's Food Ingredients business, which has experience, expertise and technologies related to the manufacture of potato starch products. Consolidated assets at August 31, 2012 included $11.3 million of assets related to the acquisition.


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Since the primary end markets for Carolina Starches' products are the paper and packaging industries, the Carolina Starches sales and marketing functions of the acquired operations are being managed by the Industrial Ingredients business; therefore, the sales, cost of sales and a majority of the operating expenses are included in the Industrial Ingredients segment's results of operations in the Consolidated Financial Statements. Sales of $14.7 million related to the acquired Carolina Starches businesses were included in the Industrial Ingredients results of operations.

In 2012, the Company redeemed 100,000 shares of its Series A 15% Cumulative Non-Voting Non-Convertible Preferred Stock ("Series A Preferred Stock") at the original issue price of $40 million plus accrued dividends of $8.9 million. See Note 6 to the Consolidated Financial Statements. The redemptions were funded with available balances on the Company's revolving credit facility.

In July 2012, in connection with Series A Preferred Stock redemption, the Company refinanced its bank debt. The Company entered into a $130 million Fourth Amended and Restated Credit Agreement which increased the Company's borrowing capacity and extended the maturity date for the revolving line of credit to July 9, 2017. See Note 7 to the Consolidated Financial Statements.

In analyzing business trends, management considers a variety of performance and financial measures, including sales revenue growth, sales volume growth, and gross margins and operating income of the Company's business segments.

Results of Operations

Executive Overview - Consolidated Results of Operations

Consolidated sales increased 14.6% to $361.4 million from $315.4 million.

Sales growth was driven by volume increases in the Food Ingredients business, pricing improvements in both the Food Ingredients and Industrial Ingredients businesses and sales contributed by the acquisition of Carolina Starches in January 2012.

Consolidated gross margin as a percent of sales improved to 12.2% from 10.7% last year. Gross margin was higher by $10.1 million primarily on favorable average pricing and product mix in both ingredients businesses.

In fiscal 2012, the Company redeemed $40 million of its Series A Preferred Stock plus $8.9 million of accrued dividends. In connection with the redemption, the Company recorded $5.5 million of discount accretion and $1.1 million of issuance cost amortization as a loss on the redemption in other non-operating income (expense) due to the early redemption of the Series A Preferred Stock.

Interest expense for fiscal 2012 decreased $0.7 million from the prior year primarily due to the redemptions of the Series A Preferred Stock in April 2012 ($16.5 million) and July 2012 ($23.5 million) which were funded by the Company's revolving line of credit. The interest rates on the bank debt are based on LIBOR or the bank's prime rate plus a margin. The dividend rate on the Series A Preferred Stock was 15%.

The Company recorded $4.8 million of tax expense on a pretax loss of $4.8 million. The effective tax rate for fiscal 2012 varied from the U.S. federal statutory rate of 35% primarily due to a $1.8 million valuation allowance related to carryforwards of tax incentives for the production of ethanol and by $13.0 million of dividends, discount accretion and amortization of issuance costs on the Series A Preferred Stock which are included in the consolidated results of operations for financial reporting purposes but are not deductible in the computation of taxable income.

The holder of 100,000 shares of Series B Preferred Stock converted the preferred shares into 1,000,000 shares of the Company's common stock.


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Results of Operations

Fiscal 2012 Compared to Fiscal 2011

Industrial Ingredients



                                              Year Ended August 31,
                                               2012            2011
                                             (Dollars in thousands)
               Sales - industrial starch   $    156,945      $ 127,471
               Sales - ethanol                  101,874        105,730

               Total sales                 $    258,819      $ 233,201
               Gross margin                $     11,744      $   7,523
               Loss from operations        $       (928 )    $  (4,718 )

Industrial Ingredients fiscal 2012 sales of $258.8 million grew $25.6 million, or 11%, over fiscal 2011. Sales of industrial starch products of $14.7 million related to the acquisition of the Carolina Starches business in mid-January 2012 were included in the Industrial Ingredients operating results for fiscal 2012. Industrial corn starch sales of $142.3 million increased 12% primarily on a higher pass through of corn costs to customers, with volume comparable to fiscal 2011. Sales of bioproducts, included in the industrial starch sales amount, improved 22% in fiscal 2012, driven by volume increases of 16% and favorable pricing and product mix of 6%. Fiscal 2012 sales of ethanol constituted 39% of industrial sales in fiscal 2012 compared to 45% in fiscal 2011. A decrease in pricing per gallon and lower volume contributed equally to the revenue decline of 4%.

Gross margin improved $4.2 million to $11.7 million in fiscal 2012 from $7.5 million a year ago. Margins improved due to the addition of $0.5 million of margin from the acquired businesses of Carolina Starches since acquisition in January 2012, favorable starch pricing of $5.8 million and lower natural gas costs of $2.4 million offset by higher net corn costs of $2.4 million, lower volume of $0.4 million, higher chemical costs of $0.8 million, and higher manufacturing costs of $0.9 million.

The loss from operations for fiscal 2012 improved $3.8 million to $0.9 million from a loss of $4.7 million last year, primarily due to the increase in gross margin. Operating expenses of $9.6 million in fiscal 2012, which included $0.8 million from the acquired business of Carolina Starches, were comparable to the prior year. Higher research and development expenses of $0.4 million were due to increased activity in bioproducts development.

Food Ingredients



                                             Year Ended August 31,
                                              2012             2011
                                            (Dollars in thousands)
                 Sales                    $     102,544      $ 82,240
                 Gross margin             $      32,165      $ 26,311
                 Income from operations   $      21,591      $ 18,037

Sales of $102.5 million for the year ended August 31, 2012, increased 24.7%, or $20.3 million, on volume growth of 16% and favorable product mix and pricing of 8%. Sales of non-coating applications expanded 29%, with revenues from gluten-free applications and pet chews and treats growing at double-digit rates. Sales of coating applications expanded 18% on higher volume of 10% and an 8% improvement in product mix and pricing.

Gross margin improved $5.9 million in fiscal 2012 over the prior year. Increased volume contributed $1.1 million with the remaining increase due to favorable pricing and product mix. Income from operations grew $3.6 million on the increase in gross margin, partially offset by higher operating and research and development


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expenses. Operating expenses increased $1.6 million to $7.8 million on higher employee costs and professional fees and $0.9 million of costs from the acquired operations of Carolina Starches. Higher research and development expenses of $0.7 million are due to additional personnel in fiscal 2012 and higher legal costs.

Corporate Operating Expenses

Corporate operating expenses increased to $10.6 million in fiscal 2012 from $8.9 million a year ago due to increases in employee costs and legal, accounting and auditing costs incurred in connection with the acquisition of Carolina Starches and a registration statement.

Fiscal 2011 Compared to Fiscal 2010

Industrial Ingredients



                                              Year Ended August 31,
                                               2011            2010
                                             (Dollars in thousands)
               Sales - industrial starch   $    127,471      $ 115,681
               Sales - ethanol                  105,730         68,335

               Total sales                 $    233,201      $ 184,016
               Gross margin                $      7,523      $     461
               Loss from operations        $     (4,718 )    $ (11,512 )

Industrial Ingredients fiscal 2011 sales of $233.2 million grew $49.2 million, or 26.7%, from fiscal 2010. Industrial starch sales of $127.5 million increased 10.2% primarily on a higher pass through of corn costs to customers, offset by a 7% decrease in volume. Sales of the Company's bioproducts, included in the industrial starch sales amount, improved 19% driven by a volume increase of 14% and higher average unit pricing of 4%. During fiscal 2011, the Industrial Ingredients business continued to shift more of its manufacturing mix to the production of ethanol. Sales of ethanol constituted 45% of industrial sales in fiscal 2011 compared to 37% in fiscal 2010. Revenue expanded 55% to $105.7 million as pricing per gallon improved 44% and volume increased 8%.

Gross margin improved $7.0 million to $7.5 million in fiscal 2011 from $0.5 million a year ago. Margins improved due to higher ethanol pricing of $32.2 million, favorable energy costs of $2.0 million, improvements in manufacturing yields of $2.2 million, and reduced distribution costs of $1.2 million, offset by higher corn costs of $27.5 million, higher chemical costs of $1.6 million, and unfavorable industrial starch pricing and mix of $1.5 million.

The loss from operations for fiscal 2011 improved $6.8 million to $4.7 million from a loss of $11.5 million last year, primarily due to the increase in gross margin. Operating expenses of $9.6 million were comparable to fiscal 2010. An increase in the reserve for uncollectible accounts of $1.5 million in fiscal 2011 due to two paper industry customers, and higher employee costs, license fees and other expenses of $0.8 million were offset by a $2.3 million reduction in legal costs.

Food Ingredients



                                             Year Ended August 31,
                                              2011             2010
                                            (Dollars in thousands)
                 Sales                    $     82,240       $ 70,258
                 Gross margin             $     26,311       $ 22,993
                 Income from operations   $     18,037       $ 15,145


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Sales of $82.2 million for the year ended August 31, 2011, increased 17.1%, or $12.0 million, on volume growth of 7% and favorable product mix and pricing of 10%. Sales of non-coating applications expanded 44%, with revenues from gluten-free applications and pet chews and treats more than doubling. Sales of coating applications declined 11% due to lower volume.

Gross margin improved $3.3 million due to the favorable pricing and mix of product sales and growth in non-coating sales. Income from operations grew 19% on the increase in gross margin. Operating expenses increased $0.3 million to $6.2 million on higher employee costs. Research and development expenses increased $0.1 million to $2.1 million.

Corporate Operating Expenses

Corporate operating expenses increased to $8.8 million in fiscal 2011 from $8.4 million a year ago, primarily due to an increase in employee-related costs.

Non-Operating Income (Expense)

Other non-operating income (expense) consists of the following:



                                                          Year Ended August 31,
                                                       2012        2011        2010
                                                          (Dollars in thousands)
    Loss on redemption of Series A Preferred Stock   $ (6,599 )    $  -      $     -
    Loss on extinguishment of debt                         -       $  -        (1,049 )
    Loss on interest rate swap termination                 -          -        (1,562 )
    Gain on foreign currency transactions                  -          -           419
    Other                                                 413        115          271

                                                     $ (6,186 )    $ 115     $ (1,921 )

In 2012, the Company redeemed 100,000 shares of its Series A 15% Cumulative Non-Voting Non-Convertible Preferred Stock ("Series A Preferred Stock") at the original issue price of $40 million plus accrued dividends of $8.9 million. See Note 6 to the Consolidated Financial Statements. As a result of the early redemptions, the Company recorded accelerated discount accretion of $5.5 million and amortization of issuance costs of $1.1 million as a loss on redemption in other non-operating income (expense).

In 2010, the Company refinanced its bank debt. See Note 7 to the Consolidated Financial Statements. In connection with the refinancing, the Company recorded a pre-tax non-cash charge to earnings of approximately $1.0 million related to unamortized transaction fees associated with the prior credit facility. In addition, the Company terminated its interest rate swap agreements with several banks and recorded a loss of approximately $1.6 million.

Interest expense

Interest expense was $8.6 million, $9.4 million and $7.5 million in fiscal years 2012, 2011 and 2010, respectively. Interest expense for fiscal years 2012 and 2011 increased over fiscal 2010 primarily due to the increase in the dividend rate on the Series A Preferred Stock issued in April 2010 over the interest rate for the Company's bank debt. Interest expense for fiscal 2012 decreased $0.7 million from the prior year primarily due to the redemptions of the Series A Preferred Stock in April 2012 ($16.5 million) and July 2012 ($23.5 million) which were funded by the Company's revolving line of credit. The accretion of the discount on the Series A Preferred Stock and the amortization of issuance costs, which are included in interest expense, were $1.0 million, $1.2 million and $0.5 million for the years ended August 31, 2012, 2011 and 2010, respectively. See Notes 6 and 7 to the Consolidated Financial Statements.


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Income taxes

In fiscal 2012, the Company recorded $4.8 million of tax expense on a pretax loss of $4.8 million. The effective tax rate for fiscal 2012 differs from the U.S. federal statutory rate due to $13.0 million of non-deductible expenses related to the Company's Series A Preferred Stock ($5.4 million of dividends, $6.3 million of discount amortization and $1.3 million of amortization of issuance costs) and a $1.8 million valuation allowance. In fiscal 2012, the Company recorded a valuation allowance related to small ethanol producer tax credit carryforwards which expire in fiscal 2014. Tax laws require that any net operating loss carryforwards be utilized before the Company can utilize the small ethanol producer tax credit carryforwards. Due to the near-term expiration of the small ethanol producer tax credit carryforward period, the Company does not believe it has sufficient positive evidence to substantiate that the small ethanol tax credit carryforwards are realizable at a more-likely-than-not level of assurance and recorded a $1.8 million valuation allowance. The valuation allowance will be reversed in future periods if these tax credit carryforwards are utilized. See Note 16 to the Consolidated Financial Statements.

At August 31, 2012, the Company had $13.3 million of net deferred tax assets. A valuation allowance has not been provided on the remaining net U.S. deferred tax assets as of August 31, 2012. The determination of the need for a valuation allowance requires significant judgment and estimates. The Company evaluates the requirement for a valuation allowance each quarter. Over half of the net deferred tax assets relate to net operating loss carryforwards which expire in 2030. The Company believes that it is more likely than not that future operations will generate sufficient taxable income to realize its deferred tax assets. There can be no assurance that management's current plans will be achieved or that an additional valuation allowance will not be required in the future.

In fiscal 2011, the Company recorded $0.3 million of tax expense on a pretax loss of $4.8 million. The effective tax rate for fiscal 2011 varied from the U.S. federal statutory rate of 35% primarily due to tax incentives for the production of ethanol of $1.0 million, offset by $7.7 million of dividends and discount accretion on the preferred stock which are recorded as interest expense for financial reporting purposes but are not deductible in the computation of taxable income.

The effective tax rate for fiscal 2010 of 33% is lower than the U.S. federal statutory rate of 35% primarily due to tax incentives for the production of ethanol of $1.0 million, offset by the effect of state taxes and $2.9 million of dividends and discount accretion on the preferred stock as described above.

Discontinued Operations

In fiscal 2010, the Company sold the operating assets of its Australia/New Zealand Operations. The financial results of the Australia/New Zealand Operations for fiscal 2010 have been classified as discontinued operations in the Consolidated Financial Statements. Australian administrative expenses of $0.1 million for each of the years ended August 31, 2012 and 2011 were included in income from continuing operations. The net assets of the Australia/New Zealand Operations as of August 31, 2012 have been reported as assets and liabilities of the continuing operations in the Consolidated Balance Sheets.

At August 31, 2012, the remaining net assets of the Australia/New Zealand Operations consist of $0.1 million of cash and $0.8 million of other net assets, primarily a receivable from the purchaser of one of the Company's Australian manufacturing facilities. See Note 22 for claims related to the collection of this receivable.


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Liquidity and Capital Resources

The Company's primary sources of short- and long-term liquidity are cash flow from operations and its revolving line of credit, which expires on July 9, 2017. The Company expects to generate sufficient cash flow from operations and to have sufficient borrowing capacity and ability to fund its cash requirements during fiscal 2013.

                                                            Year Ended August 31,
                                                    2012             2011            2010
                                                            (Dollars in thousands)
Net cash flow provided by operating
activities                                        $   2,765        $  2,915        $  10,068
Net cash provided by (used in) investing
activities                                          (22,418 )        (8,253 )         14,732
Net cash provided by (used in) financing
activities                                           19,526           5,304          (30,388 )
Net cash used in discontinued operations                 -               -              (271 )

Net decrease in cash                              $    (127 )      $    (34 )      $  (5,859 )

Operating Activities

At August 31, 2012, Penford had working capital of $55.8 million, and $82.6 million outstanding under its $130 million revolving credit facility. Cash flow generated from operations of $2.8 million in fiscal year 2012 was comparable to operating cash flow in the prior year.

The decline in operating cash flow between fiscal 2010 and fiscal 2011 was primarily due to working capital requirements. Working capital used $9.9 million of cash during the year ended August 31, 2011 compared to cash contributed by working capital of $8.9 million during fiscal 2010. Changes in working capital requirements were due to (1) increases in inventories and accounts receivable due to higher sales as well as the higher cost of corn, (2) a $6.4 million contribution to the Company's pension plans in fiscal 2011, and (3) offset by income tax refunds received of $3.4 million.

Investing Activities

Capital expenditures were $14.1 million, $8.3 million and $6.0 million in fiscal years 2012, 2011 and 2010, respectively. Penford expects capital expenditures to be approximately $15-18 million in fiscal 2013.

In fiscal 2012, the Company purchased the businesses of Carolina Starches for $8.5 million in cash. Cash acquired in the purchase transaction was $0.2 million. See Note 19 to the Consolidated Financial Statements.

Repayments of intercompany loans by the Company's Australian discontinued operations in fiscal 2010 are reflected as cash provided by investing activities.

Financing Activities

Preferred Stock

In fiscal 2010, the Company issued $40.0 million of mandatorily redeemable Series A 15% cumulative non-voting, non-convertible preferred stock ("Series A Preferred Stock") and 100,000 shares of Series B voting convertible preferred stock ("Series B Preferred Stock") in a private placement to Zell Credit Opportunities Master Fund, L.P., an investment fund managed by Equity Group Investments, a private investment firm (the "Investor"). Proceeds from the preferred stock issuance of $40.0 million were used to repay bank debt in fiscal 2010.

During fiscal 2012, the Company redeemed all of its Series A Preferred Stock at the original issue price of $40.0 million plus accrued dividends of $8.9 million. As a result of the early redemption, the Company recorded accelerated discount accretion of $5.5 million and amortization of issuance costs of $1.1 million as a loss on the redemption in other non-operating income (expense). The redemptions were funded by available balances on the Company's revolving line of credit.


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During fiscal 2012, the Investor converted its 100,000 shares of Series B Preferred Stock into 1,000,000 shares of the Company's common stock. See Note 6 to the Consolidated Financial Statements.

Bank Debt

In fiscal 2010, the Company used the proceeds from the $40.0 million preferred stock issuance discussed above to pay a portion of the outstanding bank debt obligations. Concurrent with the preferred stock issuance, the Company refinanced its bank debt and entered into a $60 million Third Amended and Restated Credit Agreement (the "2010 Agreement") with a lending syndicate with Bank of Montreal; Bank of America National Association; and Cooperatieve Centrale Raiffeisen-Boerenleenbank B.A., "Rabobank Nederland" New York Branch.

In July 2012, in connection with the redemption of preferred stock discussed above, the Company refinanced its obligations then outstanding under the 2010 Agreement. The Company entered into a $130 million Fourth Amended and Restated Credit Agreement (the "2012 Agreement") with Bank of Montreal; Cooperatieve Centrale Raiffeisen-Boerenleenbank B.A., "Rabobank Nederland" New York Branch; KeyBank National Association; JPMorgan Chase Bank N.A.; First Midwest Bank; Private Bank and Trust Company; Greenstone Farm Credit Services, ACA/FLCA and Bank of America, N.A.

Under the 2012 Agreement, the Company may borrow $130 million in revolving lines of credit. The lenders' revolving credit loan commitment may be increased under certain conditions. Under the 2012 Agreement, there are no scheduled principal payments prior to maturity on July 9, 2017.

At August 31, 2012, the Company had $82.6 million outstanding under the 2012 Agreement, which is subject to variable interest rates. Interest rates under the 2012 Agreement are based on either the London Interbank Offering Rates ("LIBOR") or the prime rate, depending on the selection of available borrowing options under the 2012 Agreement. Pursuant to the 2012 Agreement, the interest rate margin over LIBOR ranges between 2% and 4%, depending upon the Total Leverage Ratio (as defined).

The 2012 Agreement provides that the Total Leverage Ratio, which is computed as funded debt divided by earnings before interest, taxes, depreciation and amortization (as defined in the 2012 Agreement) shall not exceed 3.75 through November 30, 2012; 3.50 through November 30, 2013; 3.25 through May 31, 2014; and 3.0 thereafter. In addition, the Company must maintain a Fixed Charge Coverage Ratio, as defined in the 2012 Agreement, of not less than 1.35. Annual capital expenditures would be restricted to $15 million beginning in fiscal 2013 if the Total Leverage Ratio is greater than 2.50 for two consecutive fiscal quarters. The Company's obligations under the 2012 Agreement are secured by . . .

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