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PENX > SEC Filings for PENX > Form 10-Q/A on 8-Jul-2013All Recent SEC Filings

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Form 10-Q/A for PENFORD CORP


8-Jul-2013

Quarterly Report


Item 2: Management's Discussion and Analysis of Financial Condition and Results of Operations

Restatement of Previously Issued Financial Statements

The Company had previously recorded the proceeds from the sale of by-products from its Cedar Rapids, Iowa, manufacturing operations as a reduction of cost of sales. The Company believed that this accounting treatment was consistent with accounting principles generally accepted in the United States. After several months of consultation and review with the Staff of the Securities and Exchange Commission, the Company and the Company's Audit Committee concluded that the proceeds from the sale of by-products should be classified as sales rather than as a reduction of cost of sales in the Condensed Consolidated Statements of Operations.

The adjustments to sales and cost of sales shown below affect the amounts previously reported for the Company's consolidated and Industrial Ingredients segment sales and cost of sales. The following is a reconciliation of sales and cost of sales as previously reported to the restated amounts. The adjustments do not affect the Company's previously reported gross margin, income (loss) from operations, net income (loss) or earnings (loss) per share in the Condensed Consolidated Statements of Operations for the three- and six-month periods ended February 28, 2013 and February 29, 2012 or to any items reported in the Condensed Consolidated Balance Sheets or the Condensed Consolidated Statements of Comprehensive Income (Loss), Cash Flows or Stockholders' Equity. See Note 2 to the Condensed Consolidated Financial Statements.

                                       As Previously
                                         Reported          Adjustment       As Restated
                                                    (Dollars in thousands)
 Quarter Ended February 28, 2013
 Consolidated sales                   $        89,037     $     21,045     $     110,082
 Consolidated cost of sales                    78,036           21,045            99,081
 Industrial Ingredient sales                   62,433           21,045            83,478
 Quarter Ended February 29, 2012
 Consolidated sales                   $        86,188     $     17,289     $     103,477
 Consolidated cost of sales                    76,787           17,289            94,076
 Industrial Ingredient sales                   61,284           17,289            78,573
 Six Months Ended February 28, 2013
 Consolidated sales                   $       183,896     $     44,208     $     228,104
 Consolidated cost of sales                   159,637           44,208           203,845
 Industrial Ingredient sales                  129,638           44,208           173,846
 Six Months Ended February 29, 2012
 Consolidated sales                   $       176,934     $     34,711     $     211,645
 Consolidated cost of sales                   155,725           34,711           190,436
 Industrial Ingredient sales                  126,106           34,711           160,817

In addition to the amounts restated above, the Company has also corrected an error in the consolidated statements of cash flows to classify proceeds and payments related to a short term financing arrangement as a financing activity rather than as an operating activity. The net amount of proceeds and repayments previously reflected as a "Change in operating assets and liabilities - accounts payable and accrued liabilities" of $(893,000) and $(253,000) for the six months ended February 28, 2013 and February 29, 2012, respectively, have been corrected within financing activities at their appropriate gross amounts of proceeds and payments for each respective period.

In connection with the restatement discussed above in the explanatory note to this Quarterly Report on Form 10-Q/A ("10-Q/A") and in Note 2 to the Condensed Consolidated Financial Statements, under the supervision and with the participation of management, including the Chief Executive Officer and the Chief Financial Officer, the Company reevaluated the effectiveness of its disclosure controls and procedures. Based upon that reevaluation, a material weakness was identified as described in Part I Item 4 of this 10-Q/A, and the Company concluded that its disclosure controls and procedures and internal control over financial reporting were not effective as of February 28, 2013. See Item 4 for a discussion of the material weakness and management's remediation plan.

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.


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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 11 to the Condensed Consolidated Financial Statements for additional information regarding the Company's business segment operations. In January 2012, the Company acquired, through purchase or lease, the net assets and operations of Carolina Starches, which manufactures and markets industrial potato starch based products for the paper and packaging industries. The net assets and results of operations of the Carolina Starches business 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.

Since the primary end markets for Carolina Starches' products are the paper and packaging industries, the 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 Condensed Consolidated Financial Statements and this Part I Item 2.

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

This Management's Discussion and Analysis of Financial Condition and Results of Operations ("MD&A") should be read in conjunction with the Company's condensed consolidated financial statements and the accompanying notes. The notes to the Condensed Consolidated Financial Statements referred to in this MD&A are included in Part I Item 1, "Financial Statements."

Results of Operations

Executive Overview

Quarters ended February 28, 2013 and February 29, 2012:

Net income for the quarter ended February 28, 2013 was $1.2 million, or $0.10 per diluted share, compared to a net loss of $0.3 million, or $0.03 per diluted share last year.

Consolidated sales increased 6.4% to $110.1 million from $103.5 million for the same period last year.

Sales growth was driven by a volume increase in the Food Ingredients business, sales contributed by the Carolina Starches operations acquired in January 2012, and improvements in pricing and product mix in all businesses.

Consolidated gross margin as a percent of sales was 10.0% compared to 9.1% a year ago. Gross margin was higher by $1.6 million.

Interest expense dropped by $1.4 million due to lower interest rates available under the Company's bank credit facility compared with the higher borrowing costs under the Company's 15% Series A Preferred Stock which was redeemed in the third and fourth quarters of fiscal 2012.

Income tax expense for the second quarter and first half of fiscal 2013 was 27% and 34%, respectively, of pre-tax income. The difference between the effective tax rates and the statutory rate is due to state income taxes, offset by the tax benefit associated with the research and development ("R&D") tax credit. On January 2, 2013, the R&D tax credit was retroactively reinstated to January 1, 2012. The retroactive R&D credit reduced the effective tax rate by 9% and 3%, respectively, for the second quarter and first half of 2013.

Six months ended February 28, 2013 and February 29, 2012:

Net income for the six months ended February 28, 2013 rose to $2.9 million from $0.3 million in the same period last year. Earnings per diluted share were $0.23 compared to $0.02 for the first half of fiscal 2012.

Consolidated sales increased 7.8% to $228.1 million from $211.6 million last year on pricing and mix improvements in both business segments.

Consolidated gross margin as a percent of sales was 10.6% in fiscal 2013 compared to 10.0% in fiscal 2012 on improvements in corn starch manufacturing yields and costs and lower energy costs.

As discussed above for the second quarter of fiscal 2013, interest expense declined due to the redemption of the Company's preferred stock, and the Company's effective tax rate for the first half of fiscal 2013 was 34%.


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Industrial Ingredients

Second quarter fiscal 2013 sales at the Company's Industrial Ingredients business unit increased $4.9 million, or 6.2%, to $83.5 million from $78.6 million during the second quarter of fiscal 2012. This increase was primarily due to:

Second quarter fiscal 2013 included $2.8 million of additional revenue from the operations of Carolina Starches which were acquired mid-second quarter of fiscal 2012.

Industrial corn starch sales, excluding sales contributed by Carolina Starches, in the three months ended February 28, 2013 increased $4.3 million, or 13%, to $37.7 million from $33.4 million last year. Industrial starch volume expanded 4%. The remaining amount of the increase is attributable to favorable product mix and pricing, including the pass-through of net corn cost increases to customers.

Ethanol sales declined $6.0 million, or 24.9%, to $18.2 million from $24.2 million on a 28% decrease in volume, partially offset by a 4.6% increase in average unit selling prices.

Sales of by-products increased $3.8 million on favorable pricing.

Revenues for the first half of fiscal 2013 increased $13.0 million, or 8.1%, to $173.8 million from $160.8 million in the prior year. The increase was primarily due to:

Sales increased $8.2 million attributable to the operations of Carolina Starches which were acquired in January 2012.

Industrial corn starch sales, excluding sales contributed by Carolina Starches, rose $10.4 million on a 9% increase in volume and a 6% improvement in product mix and pricing, including the pass-through of increases in the net cost of corn.

Ethanol sales declined $15.1 million as volume declined 22% and pricing decreased 6%.

Sales of by-products increased $9.5 million on favorable pricing.


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Industrial Ingredients' loss from operations for the second quarter of fiscal 2013 was $0.5 million compared to an operating loss of $1.0 million in fiscal 2012. Gross margin for the second quarter of fiscal 2013 increased $1.1 million to $2.9 million. The increase was due to improvements in product mix and average unit pricing of $1.7 million and margin from the acquired Carolina Starches business of $0.4 million, partially offset by lower volume of $1.0 million. Operating and research and development expenses increased $0.6 million in the second quarter of fiscal 2013 split equally between additional expenses attributable to the acquired Carolina Starches operations and increased employee costs for bioproducts sales and marketing resources.

Industrial Ingredients' income from operations for the first half of fiscal 2013 improved $1.2 to $0.9 million. Gross margin during this period increased $2.7 million to $8.0 million. Approximately $0.9 million of the margin increase is attributable to the Carolina Starches business. Improvements in manufacturing costs and yields of $2.5 million, lower energy and chemical costs of $1.8 million, and the effect of higher starch sales of $2.6 million were partially offset by the effect of lower ethanol sales of $4.5 million and higher maintenance and other expenses of $0.6 million.

Food Ingredients

Fiscal 2013 second quarter sales for the Food Ingredients segment of $26.6 million increased 6.8%, or $1.7 million, over the second quarter of fiscal 2012, due to 5% higher volume and a 2% improvement in average unit pricing. Strong sales in non-coating applications, led by sales to the protein, dairy and gluten-free end markets, contributed almost 70% of total segment revenues and accounted for all of the sales growth in the second quarter.

Sales for the first half of fiscal 2013 increased $3.4 million, 6.7% over the previous year's sales of $50.8 million. Sales volume improved 5.7% and average unit pricing rose 1%. Higher sales of non-coating applications to the protein, soups/sauces/gravies and dairy end markets constituted over 60% of total food ingredient sales and all of the segment revenue growth.

Operating income for the second quarter of fiscal 2013 at the Company's Food Ingredients segment increased 5.5% to $5.5 million from $5.2 million in the same period last year due to an increase in gross margin of $0.5 million, partially offset by an increase in operating and research and development expenses of $0.2 million. Second quarter gross margin improved primarily due to higher sales. Operating and research and development expenses increased due to higher employee and legal costs.

Segment operating income for the first half of fiscal 2013 declined 2.8% to $10.9 million from $11.2 million in the same period last year. Gross margin improved $0.4 million on the effect of volume increases of $0.9 million, offset by increased manufacturing input costs of $0.5 million. Operating and research and development expenses increased $0.7 million due to higher employee and legal costs.

Corporate operating expenses

Corporate operating expenses of $2.5 million for the second quarter of fiscal 2013 were comparable to the prior year. Corporate operating expenses for the first six months of fiscal 2013 increased $0.3 million to $5.2 million from $4.9 million in the same period last year due to an increase in employee costs.

Non-operating income (expense)

Non-operating income in the second quarter of fiscal 2013 consisted primarily of the reversal of an allowance for a claim against escrow funds made by the purchaser of the Company's Lane Cove, New South Wales, Australia operating assets which were sold in fiscal 2010. See Note 13 to the Condensed Consolidated Financial Statements.

Interest expense

In the third and fourth quarters of fiscal 2012, the Company redeemed $40.0 million of its outstanding Series A 15% Cumulative Preferred Stock (the "Preferred Stock"). The redemptions were funded with available balances on the Company's revolving credit facility. Dividends and discount accretion on the Preferred Stock were recorded as interest expense in fiscal 2012. Interest expense for the three- and six-month periods ended February 28, 2013 decreased $1.4 million and $2.8 million, respectively, from the same periods in fiscal 2012. The decrease was primarily due to the lower interest rates available to the Company under its credit facility compared with the higher dividend rate on the Preferred Stock. The interest rate on the Company bank debt was based on a margin over LIBOR (London Interbank Offered Rate).


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Income taxes

The Company's effective tax rates for the three- and six-month periods ended February 28, 2013 were 27% and 34%, respectively. The difference between the effective tax rates and the U.S. federal statutory tax rate was primarily due to state income taxes, offset by the tax benefit associated with the research and development tax credit. On January 2, 2013, the American Taxpayer Relief Act of 2012 was enacted, which retroactively reinstated, to January 1, 2012, several corporate tax provisions that had expired, including the research and development tax credit. The Company recorded $0.15 million in the second quarter of fiscal 2013 related to this tax credit for research and development activities in fiscal 2012, which reduced the effective tax rates by 9% and 3% for the three- and six-month periods ended February 28, 2013.

The Company's effective tax rate for the first half of fiscal 2012 was 82%. The difference between the effective tax rate and the U.S. federal statutory tax rate was primarily due to state income taxes and dividends and accretion of discount on the Company's 15% Series A Preferred Stock. The dividends and accretion of discount were reported as interest expense in the Condensed Consolidated Statements of Operations but were not deductible for tax return purposes. The Series A Preferred Stock was redeemed in the third and fourth quarters of fiscal 2012.

In fiscal 2012, the Company recorded a $1.8 million valuation allowance primarily 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.

At February 28, 2013, the Company had $12.7 million of net deferred tax assets. Other than for the ethanol tax credit carryforwards discussed above, a valuation allowance has not been provided on the net U.S. deferred tax assets as of February 28, 2013. 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. The Company believes that it is more likely than not that future operations and the reversal of existing taxable temporary differences will generate sufficient taxable income to realize its deferred tax assets, except for the small ethanol producer tax credit carryforwards, for which a valuation allowance has been provided.

Liquidity and Capital Resources

The Company's primary sources of short- and long-term liquidity are cash flow from operations and its bank credit facility.

Operating Activities

Cash provided by operations was $3.4 million for the six months ended February 28, 2013 compared with $9.3 million for the same period last year. The decline in operating cash flow was primarily due to higher working capital requirements. The Company has increased its inventories of corn and corn starch finished goods in response to last year's drought conditions.

Investing Activities

Cash used in investing activities of $5.0 million was for investments in capital projects. See Note 4 to the Condensed Consolidated Financial Statements. The Company expects total capital expenditures for fiscal 2013 to be approximately $12-$15 million.

Financing Activities

As of February 28, 2013, the Company had $84.0 million outstanding on its $130 million secured revolving credit facility (the "2012 Agreement") with a syndicate of banks. The lenders' loan commitment may be increased under certain circumstances.

There are no scheduled principal payments prior to maturity of the credit facility on July 9, 2017. Interest rates under the 2012 Agreement are based on either 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, which is computed as funded debt divided by earnings before interest, taxes, depreciation and amortization (as set forth in the 2012 Agreement).

The 2012 Agreement provides that the Total Leverage Ratio shall not exceed 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 will be restricted to $15 million 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 substantially all of the Company's assets.


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Pursuant to the 2012 Agreement, the Company may declare and pay dividends on its common stock in an amount not to exceed, in any consecutive four quarters, the lesser of $10 million or 50% of Free Cash Flow, as defined in the 2012 Agreement. As of February 28, 2013, the Company was not permitted to pay dividends.

Contractual Obligations

The Company is a party to various debt and lease agreements at February 28, 2013 that contractually commit the Company to pay certain amounts in the future. The Company also has open purchase orders entered into in the ordinary course of business for raw materials, capital projects and other items, for which significant terms have been confirmed. There have been no material changes in the Company's contractual obligations since August 31, 2012.

Off-Balance Sheet Arrangements

The Company had no off-balance sheet arrangements at February 28, 2013.

Recent Accounting Pronouncements

In February 2013, the FASB issued guidance requiring entities to provide information about the amounts reclassified out of accumulated other comprehensive income by component. Entities are required to present, either on the face of the financial statements or in the notes, significant amounts reclassified out of accumulated other comprehensive income by the respective line items of net income. This guidance, which is effective prospectively for reporting periods beginning after December 15, 2012, does not change the current requirements for reporting net income or other comprehensive income. The Company is evaluating the impact this guidance will have on its disclosures.

In December 2011, the FASB issued guidance creating new disclosure requirements about the nature of an entity's rights of setoff and related arrangements associated with its financial instruments and derivative instruments. The disclosure requirements are effective for annual reporting periods, and interim reporting periods within those years, beginning on or after January 1, 2013 (fiscal 2014 for Penford). The Company is evaluating the impact this update will have on its disclosures.

Critical Accounting Policies and Estimates

The Company's consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States. The process of preparing financial statements requires management to make estimates, judgments and assumptions that affect the Company's financial position and results of operations. These estimates, judgments and assumptions are based on the Company's historical experience and management's knowledge and understanding of the current facts and circumstances. See the Company's Annual Report on Form 10-K/A for the fiscal year ended August 31, 2012 for a description of critical accounting policies and methods used in the preparation of the consolidated financial statements. Management believes that its estimates, judgments and assumptions are reasonable based upon information available at the time this report was prepared. To the extent there are material differences between estimates, judgments and assumptions and the actual results, the financial statements will be affected.

Forward-looking Statements

This Quarterly Report on Form 10-Q/A ("Quarterly Report"), including but not limited to statements found in the Notes to Condensed Consolidated Financial Statements and in Item 2 - Management's Discussion and Analysis of Financial Condition and Results of Operations, contains statements that are forward-looking statements within the meaning of the federal securities laws. In particular, statements pertaining to anticipated operations and business strategies contain forward-looking statements. Likewise, statements regarding anticipated changes in the Company's business and anticipated market conditions are forward-looking statements. Forward-looking statements involve numerous risks and uncertainties and should not be relied upon as predictions of future events. Forward-looking statements depend on assumptions, dates or methods that may be incorrect or imprecise, and the Company may not be able to realize them. Forward-looking statements can be identified by the use of forward-looking terminology such as "believes," "expects," "may," "will," "should," "seeks," "approximately," "intends," "plans," "estimates," or "anticipates," or the negative use of these words and phrases or similar words or phrases. Forward-looking statements can be identified by discussions of strategy, plans or intentions. Readers are cautioned not to place undue reliance on these forward-looking statements which are based on information available as of the date of this report. The Company does not undertake any obligation to publicly update or revise any forward-looking statements to reflect future events, information or circumstances that arise after the date of the filing of this Quarterly Report. Among the factors that could cause actual results to differ materially are the risks and uncertainties discussed in this Quarterly Report, including those referenced in Part II Item 1A of this Quarterly Report, and those described from time to time in other filings made with the Securities and Exchange Commission, including the Company's Annual Report on Form 10-K/A for the year ended August 31, 2012, which include but are not limited to:

competition;

the possibility of interruption of business activities due to equipment problems, accidents, strikes, weather or other factors;


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product development risk;

changes in corn and other raw material prices and availability;

changes in general economic conditions or developments with respect to specific industries or customers affecting demand for the Company's products including unfavorable shifts in product mix or changes in government rules or incentives affecting ethanol consumption;

unanticipated costs, expenses or third-party claims;

the risk that results may be affected by construction delays, cost overruns, technical difficulties, nonperformance by contractors or changes in capital improvement project requirements or specifications;

interest rate, chemical and energy cost volatility;

changes in returns on pension plan assets and/or assumptions used for determining employee benefit expense and obligations;

. . .

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