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MGPI > SEC Filings for MGPI > Form 10-Q on 9-Nov-2012All Recent SEC Filings

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Form 10-Q for MGP INGREDIENTS INC


9-Nov-2012

Quarterly Report


ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.

(Dollar amounts in thousands, unless otherwise noted)

As used in Management's Discussion and Analysis, unless the context otherwise requires, the terms "Company," "we," or "our" when referenced to after the Reorganization mean MGP Ingredients, Inc. (formerly named MGPI Holdings, Inc.) and its consolidated subsidiaries, and these same terms when referenced prior to the Reorganization mean Processing (formerly named MGP Ingredients, Inc.) and its consolidated subsidiaries.

As previously announced, on August 25, 2011 we changed our fiscal year end from June 30 to December 31. We filed a transition report on Form 10-K with the SEC for the period beginning July 1, 2011 and ending December 31, 2011. The discussion below compares results for the quarter and year to date periods ended September 30, 2012 to the quarter and nine-month to date periods ended September 30, 2011.

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 Items 8 and Item 7, respectively of our Form 10-K for the six-month transition period ended December 31, 2011.

RECENT INITIATIVES

Acquisition of the Indiana Distillery

On December 27, 2011, we acquired substantially all the assets used by Lawrenceburg Distillers Indiana, LLC ("LDI") in its beverage alcohol business, and we now produce premium bourbon, corn and rye whiskeys, gin, grain neutral spirits and distillers feed at our distillery located in Lawrenceburg and Greendale, Indiana ("Indiana Distillery"). The purchase price of the acquisition was equal to the current assets minus current liabilities as of December 27, 2011, which was estimated at closing to be $11,041. During April 2012, management and the seller completed working capital true-ups. The result of the true-ups was not material to our financial position or operating results.

Since acquiring the distillery operations of LDI, we have taken several steps to improve its profitability. During the second quarter of the current fiscal year, we completed the planning stages of implementing an SAP information technology system for accounting, sales, supply chain and manufacturing at this facility. We went live on SAP on July 1, 2012.

During the quarter ended March 31, 2012, MGPI-I and the union that covers certain employees at the Indiana Distillery ratified a new multi-year collective bargaining unit agreement, that will terminate December 31, 2017.

In conjunction with the acquisition of the distillery operations of LDI, we acquired a grain elevator that was not expected to be used, which was reported as Assets held for sale at December 31, 2011. On March 21, 2012, we sold this facility and its related assets for $2,252, resulting in a loss of $48. Net proceeds received, after fees and prorated taxes, totaled $2,232.


Ownership change of ICP

On February 1, 2012, Illinois Corn Processing Holdings ("ICP Holdings"), an affiliate of SEACOR Energy, Inc., exercised its option to purchase from us an additional 20 percent of the membership interest in ICP. The proceeds for this sale approximated $9,103. Following its exercise, ICP Holdings owns 70 percent of ICP, is entitled to name 4 of ICP's 6 advisory board members, and generally has control of ICP's day-to-day operations. The Company owns 30 percent of ICP and is entitled to name 2 of ICP's 6 advisory board members. The transaction resulted in a pre-tax gain of $4,055 during the quarter ended March 31, 2012.

Grain Supply Agreements

During the quarter ended March 31, 2012, we entered a grain supply contract for the Indiana Distillery and during the quarter ended June 30, 2012 we extended this agreement for use at our Atchison facility. The grain supply contracts permit us to purchase corn for delivery up to 12 months in the future, at negotiated prices. The pricing for these contracts is based on a formula using several factors.

Supply for commodities has been tight during the first nine months of 2012 due, in part, to the drought in the Midwestern United States. Market prices for commodities, including corn, have been near historic highs in summer of 2012, reaching a high in August 2012. This impacts the pricing we pay under our grain supply agreements.

Use of Hedge Accounting

Reducing earnings volatility from commodity price swings has long been at the forefront of our risk management strategy, and in early calendar 2011, the Company's Board of Directors made the decision to adopt hedge accounting. Effective July 1, 2011, we elected to restart the use of hedge accounting for qualifying derivative contracts entered into on and after July 1, 2011. For further discussion related to the accounting policy and accounting requirements for our derivative instruments, see Note 1. Accounting Policies and Basis of Presentation - Derivatives and Note 6. Derivative Instruments and Fair Value Measurements set forth in Part I, Item 1.

Our utilization of hedge accounting proved to mitigate a portion of our earnings volatility that had been experienced over the few years leading up to the restart of hedge accounting.

In connection with our new grain supply agreements discussed above, we now order corn anywhere from a month to 12 months in the future. We have determined that the firm commitments to purchase corn under the terms of these new agreements meet the normal purchases and sales exception as defined under ASC 815, Derivative and Hedging, and exclude the fair value of these commitments from recognition in our financial statements until the actual contracts are physically settled. Accordingly, during the quarter ended March 31, 2012, we de-designated certain cash flow hedges, which resulted in a reclassification of a $27 loss from accumulated other comprehensive income into earnings for the quarter ended March 31, 2012. We expect the volume of corn futures and options and the use of hedge accounting to be reduced in the future under our current strategy. In support of this strategy, as of September 30, 2012, we had no exchange traded corn futures contracts designated as cash flow hedges.

RESULTS OF OPERATIONS

Consolidated earnings for the quarter ended September 30, 2012 increased compared to the same period a year ago, with a net income of $418 on consolidated net sales of $76,107 versus a net loss of $5,509 on consolidated net sales of $76,138 in the quarter ended September 30, 2011.


The small decrease in net sales was primarily the result of our decreased sales in the ingredients solutions segment partially offset by a sales increase in the distillery products segment. In our distillery products segment, our pricing increased, partially offset by a decrease in volume compared to the same period a year ago. In our ingredient solutions segment, we experienced a decrease in volume, partially offset by an increase in pricing. Other segment sales increased slightly. Net income increased for the quarter ended September 30, 2012 due to higher gross margins and a lower quarter-over-quarter loss recorded related to our joint venture operations. Gross margins were impacted by a favorable swing in the mark-to-market adjustment for open derivatives. In our distillery products segment, return on sales increased from 0.6 percent for the quarter ended September 30, 2011 to 5.7 percent for the quarter ended September 30, 2012. Our return on sales in our ingredients solutions segment increased from 10.3 percent for the quarter ended September 30, 2011 to 15.4 percent for the quarter ended September 30, 2012.

Our improved quarter-over-quarter results were greatly impacted by the loss experienced during the quarter ended September 30, 2011. Contributing to our loss for the quarter ended September 30, 2011 was a $2,586 unfavorable impact to cost of sales from changes in the fair value of open derivative hedge contracts, high raw material costs, a temporary production interruption at our Atchison plant during the month of September, 2011 and our 50 percent share of losses from investment in ICP, which was similarly impacted during the quarter ended September 30, 2011 by high raw material costs and unrealized losses on open commodity derivative contracts. ICP experienced a $5,735 net loss for the quarter ended September 30, 2011, of which $2,867 was our 50 percent share.

Consolidated earnings for the year to date period ended September 30, 2012 increased compared to the same period a year ago, with net income of $1,444 on consolidated net sales of $247,985 versus a net loss of $15,066 on consolidated net sales of $209,124 in the year to date period ended September 30, 2011.

The increase in net sales was primarily the result of our increased sales volume in the distillery products segment. Our net income increased for the year to date period primarily due to:
higher gross margins,

a temporary production interruption during the quarter ended June 30, 2011, and a lag in the adjustment of alcohol prices we charged to customers not keeping pace with rising corn prices,

a $4,055 gain recorded during the quarter ended March 31, 2012 related to the sale of a 20 percent interest in our joint venture, ICP,

improved earnings from our joint venture operations, and

a favorable swing in earnings on the mark-to-market adjustment for open derivative contracts.

These increases to net income were partially offset by increased general and administrative expenses for the year to date period ended September 30, 2012 related to the LDI acquisition and our corporate restructuring.

In our distillery products segment, we achieved both volume and pricing increases compared to the same period a year ago. In our ingredient solutions segment we experienced a decrease in volume, partially offset by an increase in pricing. Other segment sales increased slightly. Pricing in our distillery products segment out-paced the increased costs for corn (exclusive of the impact related to the accounting for open commodity contracts), which led to an increase in return on sales.

In our distillery products segment, return on sales increased from 2.9 percent for the year to date period ended September 30, 2011, to 4.9 percent for the year to date period ended September 30, 2012. Pricing in our ingredients solutions segment increased while the pricing for flour decreased, which led to return on sales increasing from 3.5 percent for the year to date period ended September 30, 2011, to 11.4 percent for the year to date period ended September 30, 2012.


NET SALES

Net sales for the quarter ended September 30, 2012 decreased $31, compared to the quarter ended September 30, 2011. The decrease was primarily attributable to decreases in the ingredients solutions segment, partially offset by increased net sales in the distillery products segment. The decrease in net sales in the ingredient solutions segment was due to decreased volume partially offset by improved pricing. While production from our new Indiana Distillery, which we did not own during the same period a year ago, contributed to increased sales of food grade alcohol during the quarter ended September 30, 2012, we experienced nearly offsetting deceases in other high quality food grade and fuel alcohol revenue when compared to the quarter ended June 30, 2012, which led to a smaller than expected quarter-over-quarter increase in net sales. Our other segment experienced a de minimis increase in net sales due to slight volume and pricing increases.

Net sales for the year to date period ended September 30, 2012 increased $38,861, or 18.6 percent, compared to the quarter ended September 30, 2011. The increase was primarily attributable to increased net sales in the distillery products segment partially offset by decreased net sales in the ingredient solutions segment. Net sales in the distillery products segment as a whole increased primarily as a result of higher volumes of food grade alcohol, as well as from increased prices per unit. Expansion of our production ability from our new Indiana Distillery, which we did not own during the same period a year ago, contributed to increased sales of food grade alcohol during the year to date period ended September 30, 2012. The decrease in net sales in the ingredient solutions segment was due to decreased volume partially offset by improved pricing. Our other segment experienced a de minimis increase in net sales due to slight volume and pricing increases.

COST OF SALES

For the quarter ended September 30, 2012, cost of sales decreased $3,300, or 4.5 percent, compared to the quarter ended September 30, 2011. For the quarter ended September 30, 2012, cost of sales was 92.0 percent of net sales, which generated a gross profit margin of 8.0 percent. For the quarter ended September 30, 2011, cost of sales was 96.3 percent of net sales, which generated a gross margin of 3.7 percent.

Our lower overall costs were primarily the result of production decreases related to ingredient solutions segment as well as a decrease in total alcohol production in the distillery products segment. While production of food grade alcohol from our new Indiana Distillery, which we did not own during the same period a year ago, resulted in an increase in cost of sales during the quarter ended September 30, 2012, we experienced nearly offsetting decreases in production of other high quality food grade and fuel grade alcohol. Also contributing to the lower overall costs was a favorable quarter-over-quarter impact related to the accounting for open commodity derivative contracts, lower per-pound flour prices and natural gas prices, partially offset by higher per-bushel corn prices. For the quarter ended September 30, 2012, our open commodity contracts had a $1,773 favorable impact to cost of sales compared to a $2,586 unfavorable impact for the quarter ended September 30, 2011. We use these contracts to mitigate the impact of changes in commodity prices. We saw decreases in the per-pound cost of flour and the per-million cubic foot cost of natural gas, which averaged 1.4 percent and 19.6 percent lower, respectively, than the quarter ended September 30, 2011. On the other hand, we saw an increase in the per-bushel cost of corn (exclusive of the impact related to the accounting for open commodity contracts), which averaged 9.2 percent higher than the quarter ended September 30, 2011.

For the year to date period ended September 30, 2012, cost of sales increased $27,780, or 13.7 percent, compared to the year to date period ended September 30, 2011. For the year to date period ended September 30, 2012, cost of sales was 92.9 percent of net sales, which generated a gross profit margin of 7.1 percent. For the year to date period ended September 30, 2011, cost of sales was 96.9 percent of net sales, which generated a gross margin of 3.1 percent.


For the year to date period ended September 30, 2012, our higher overall costs were directly the result of production increases related to distillery products and higher corn prices. Expansion of our production ability of food grade alcohol from our new Indiana Distillery, which we did not own during the same period a year ago, allowed us to produce a greater volume of distillery products for the year to date period ended September 30, 2012. We saw an increase in the per-bushel cost of corn, which averaged 3.3 percent higher than the year to date period ended September 30, 2011 (exclusive of the impact related to the accounting for open commodity contracts). These cost increases were partially offset by a period-over-period favorable impact related to the accounting for open commodity derivative contracts and lower per-pound flour prices and natural gas prices. For the year to date period ended September 30, 2012, our open commodity contracts had a $2,773 favorable impact to cost of sales compared to a $6,535 unfavorable impact for the year to date period ended September 30, 2011. We used these contracts to mitigate the impact of changes in commodity prices. We saw decreases in the per-pound cost of flour and the per-million cubic foot cost of natural gas, which averaged nearly 1.5 percent and 17.2 percent lower, respectively, than the year to date period ended September 30, 2011.

For the quarter and year to date periods ended June 30, 2011, hedge accounting was not used as we did not restart our use of hedge accounting until July 1, 2011 (for qualifying derivative contracts entered into on and after July 1, 2011) as further discussed in "- Recent Initiatives" and in Note 1. Accounting Policies and Basis of Presentation set forth in Item I, Financial Statements of this Form 10-Q and incorporated herein by reference. In connection with the grain supply agreements discussed previously, we de-designated certain cash flow hedges during the quarter ended March 31, 2012. As of September 30, 2012, we had no derivative contracts designated as cash flow hedges.

SELLING, GENERAL AND ADMINISTRATIVE EXPENSES

Selling, general and administrative expenses for the quarter ended September 30, 2012 increased by $963, or 19.0 percent, compared to the quarter ended September 30, 2011. This increase was primarily due to an increase in personnel costs and management incentives programs. Personnel costs were increased due to our acquisition of LDI's beverage alcohol business in late 2011.

Selling, general and administrative expenses for the year to date period ended September 30, 2012 increased by $4,426, or 28.3 percent, compared to the year to date period ended September 30, 2011. This increase was primarily due to an increase in professional fees, higher personnel costs and management incentives programs. Professional fees increased primarily due to our corporate reorganization. The higher personnel costs were impacted by our acquisition of LDI's distillery business in late 2011.

GAIN ON SALE OF JOINT VENTURE INTEREST

As previously discussed, on February 1, 2012, ICP Holdings exercised its option to purchase from the Company an additional 20 percent of the membership interest in ICP. The sales price was $9,103 and the transaction resulted in a pre-tax gain of $4,055 for the year to date period ended September 30, 2012.


INTEREST EXPENSE

Interest expense for the quarter and year to date periods ended September 30, 2012 increased $111, and $506, respectively, compared to the same periods ended September 30, 2011. These increases were primarily the result of higher average daily balance and interest rate on our line of credit as well as higher long term debt compared to the same period a year ago. Increased borrowings resulted from the LDI acquisition as well as working capital increases.

EQUITY IN EARNINGS (LOSS) OF JOINT VENTURES

ICP

On February 1, 2012, ICP Holdings exercised its option to purchase an additional 20 percent of the membership interest in ICP. Following its exercise, the Company owns 30 percent of ICP.

For the quarter ended September 30, 2012, ICP had a loss of $448. As a 30 percent owner, our portion of the loss was $134. For the quarter ended September 30, 2011, ICP had a loss of $5,735. As a 50 percent owner, our portion of the loss was $2,867.

For the year to date periods ended September 30, 2012, ICP had earnings of $311. As a 50 percent owner for the month of January 2012 and a 30 percent owner for the months of February through September 2012, our portion of the earnings was $229. For the year to date periods ended September 30, 2011, ICP had a loss of $10,203. As a 50 percent owner, our portion of the loss was $5,002.

D.M. Ingredients, GmbH ("DMI")

For the quarters ended September 30, 2012 and 2011, DMI had earnings of $7 and $75, respectively. As a 50 percent joint venture holder, our equity in earnings was $4 and $37 for the quarters ended September 30, 2012 and 2011, respectively.

For the year to date periods ended September 30, 2012 and 2011, DMI had earnings
(loss) of $(130) and $198, respectively. As a 50 percent joint venture holder, our equity in earnings (loss) was $(65) and $99 for the year to date periods ended September 30, 2012 and 2011, respectively.

NET INCOME (LOSS)

As the result of the factors outlined above, we experienced a net income (loss) of $418 and $(5,509) in the quarter and year to date periods ended September 30, 2012, respectively, compared to a net income (loss) of $1,444 and $(15,066) in the quarter and year to date periods ended September 30, 2011, respectively.


SEGMENT RESULTS

The following is a summary of revenues and pre-tax profits / (loss) allocated to
each reportable operating segment for the quarter and year to date periods ended
September 30, 2012 and 2011. For additional information regarding our operating
segments, see Note 7. Operating Segments included under Part 1, Item 1,
Financial Statements of this Form 10-Q and incorporated herein by reference.

                                                              Quarter Ended                        Year to Date Ended
                                                    September 30,       September 30,       September 30,       September 30,
                                                        2012                2011                2012                2011
Distillery products
Net Sales                                          $        61,513     $        60,537     $       205,194     $       163,830
Pre-Tax Income                                               3,513                 379               9,960               4,673
Ingredient solutions
Net Sales                                                   14,184              15,414              41,852              44,592
Pre-Tax Income                                               2,184               1,592               4,808               1,557
Other
Net Sales                                                      410                 187                 939                 702
Pre-Tax Loss                                                   (85 )              (112 )              (332 )              (497 )

DISTILLERY PRODUCTS

Total distillery products sales revenue for the quarter ended September 30, 2012 increased $976, or 1.6 percent, compared to the quarter ended September 30, 2011. This increase was primarily attributable to an increase in sales of distillers feed of $2,986 and increased warehouse revenue of $588 for the quarter ended September 30, 2012 compared to the quarter ended September 30, 2011, resulting from the increased production capacity and storage, respectively, earned at our Indiana Distillery, which we did not own the same period a year ago. These increases were partially offset by decreases in sales of high quality alcohol and fuel alcohol. Despite adding significant production volume for our beverage alcohol sales from our recent acquisition of the Indiana Distillery, we experienced a decrease in total high quality alcohol sales due to a decrease in sales of lower grade industrial products. Pricing to our customers and the cost of corn (exclusive of the impact related to the accounting for open commodity contracts) both increased, whereas and natural gas prices decreased. For the quarter ended September 30, 2012, the per-bushel cost of corn averaged approximately 9.2 percent higher than the quarter ended September 30, 2011. The per-million cubic foot cost of natural gas averaged approximately 19.6 percent lower than the same period a year ago. As previously described in "Results of Operations", return on sales increased for quarter ended September 30, 2012 compared to the same quarter a year ago, which was primarily driven by a favorable swing in earnings related to the accounting for open commodity contracts. For the quarter ended September 30, 2012, our open commodity contracts had a $1,773 favorable impact to cost of sales compared to a $2,586 unfavorable impact for the quarter ended September 30, 2011.

Total distillery products sales revenue for the year to date period ended September 30, 2012 increased $41,364, or 25.2 percent, compared to the year to date period ended September 30, 2011. This increase was primarily attributable to an increase in sales of high quality alcohol of 24.9 percent, which was due to a 16.6 percent increase in per unit pricing as well as a 7.1 percent increase in volume compared to the same period a year ago. With the recent acquisition of the Indiana Distillery, which we did not own during the same period a year ago, we increased production for food grade alcohol sales. Also contributing to the overall sales increase in the distillery products segment were increases of $8,930 and $1,765 in distillers feed and warehousing revenue, respectively, attributable to increased production capacity and storage, from our acquisition of the Indiana Distillery for the year to date period ended September 30, 2012 compared to the year to date period ended September 30, 2011. Our pricing out-paced the increased costs for corn (exclusive of the impact related to the accounting for open commodity contracts), while natural gas pricing decreased. For the year to date period ended September 30, 2012, the per-bushel cost of corn averaged approximately 3.3 percent higher than the year to date period ended September 30, 2011. On the other hand, the per-million cubic foot cost of natural gas averaged approximately 17.2 percent lower than the same period a year ago. As previously described in "Results of Operations", return on sales increased for the year to date period ended September 30, 2012 compared to the same period a year ago, which was primarily driven by a favorable swing in earnings related to the accounting for open commodity contracts. For the year to date period ended September 30, 2012, our open commodity contracts had a $2,773 favorable impact to cost of sales compared to a $6,535 unfavorable impact for the year to date period ended September 30, 2011.


INGREDIENT SOLUTIONS

Total ingredient solutions sales revenue for the quarter ended September 30, 2012 decreased by $1,230, or 8.0 percent, compared to the quarter ended September 30, 2011. Specialty starches saw a 17.7 percent decrease in revenues compared to the same period a year ago due primarily to a volume decrease as well as a slight decrease in per unit pricing. Revenues for specialty proteins for the quarter ended September 30, 2012 decreased 5.6 percent compared to the quarter ended September 30, 2011 due to a volume decrease. Commodity starch saw a 21.1percent increase in revenues compared the same period a year ago due to per unit pricing and volume increases. Revenues for commodity starches and proteins totaled 16.8 percent and 1.0 percent of total segment sales for the quarter ended September 30, 2012 compared to 12.8 percent and 0.4 percent for the quarter ended September 30, 2011. While we experienced a quarter-over-quarter increase in our commodity products as a percentage of total segment sales, our focus remains on the production and commercialization of specialty ingredients. Our margins in the ingredient solutions segment saw an increase during the quarter ended September 30, 2012 compared to the quarter ended September 30, 2011. This was principally due to improved average selling prices, lower natural gas prices and lower raw material costs for flour. Natural . . .

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