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INGR > SEC Filings for INGR > Form 10-Q on 2-Aug-2013All Recent SEC Filings

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Form 10-Q for INGREDION INC


2-Aug-2013

Quarterly Report


MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Overview

We are a major supplier of high-quality food and industrial ingredients to customers around the world. We have 36 manufacturing plants located throughout North America, South America, Asia Pacific and Europe, the Middle East and Africa ("EMEA"), and we manage and operate our businesses at a regional level. We believe this approach provides us with a unique understanding of the cultures and product requirements in each of the geographic markets in which we operate, bringing added value to our customers. Our ingredients are used by customers in the food, beverage, animal feed, paper and corrugating, and brewing industries, among others.

Operating income, net income and diluted earnings per common share for the second quarter of 2013 decreased 8 percent, 13 percent and 14 percent, respectively, from the results of a year ago, driven principally by significantly reduced operating income in South America where economic conditions have deteriorated. We believe that our South American business will continue to be unfavorably impacted by difficult economic conditions and we anticipate that our full year 2013 diluted earnings per share will decline from 2012.

We currently expect that our available cash balances, future cash flow from operations and borrowing capacity under our credit facilities will provide us with sufficient liquidity to fund our anticipated capital expenditures, dividends, and other investing and/or financing activities for the foreseeable future.

Results of Operations

We have significant operations in North America, South America, Asia Pacific and EMEA. For most of our foreign subsidiaries, the local foreign currency is the functional currency. Accordingly, revenues and expenses denominated in the functional currencies of these subsidiaries are translated into US dollars at the applicable average exchange rates for the period. Fluctuations in foreign currency exchange rates affect the US dollar amounts of our foreign subsidiaries' revenues and expenses. The impact of currency exchange rate changes, where significant, is provided below.

For The Three and Six Months Ended June 30, 2013

With Comparatives for the Three and Six Months Ended June 30, 2012

Net Income attributable to Ingredion. Net income for the quarter ended June 30, 2013 decreased to $95.1 million, or $1.20 per diluted common share, from $109.1 million, or $1.40 per diluted common share, in the second quarter of 2012. Net income for the six months ended June 30, 2013 increased to $205.8 million, or $2.61 per diluted common share, from $203.3 million, or $2.61 per diluted common share, in the prior year period. The second quarter and first half results for 2012 included the reversal of a $13 million valuation allowance that had been recorded against net deferred tax assets of our Korean subsidiary ($0.16 per diluted common share) and after-tax charges for impaired assets and employee termination costs in Kenya of $4 million ($0.05 per diluted common share). The second quarter and first half 2012 results also included after-tax restructuring charges of approximately $2 million ($0.03 per


diluted common share) and $5 million ($0.06 per diluted common share), respectively, relating to our manufacturing optimization plan in North America. Additionally, the second quarter and first half 2012 results included after-tax costs of $1 million ($0.01 per diluted common share) and $2 million ($0.03 per diluted common share), respectively, associated with our integration of National Starch.

Without the 2012 reversal of the Korean deferred tax asset valuation allowance, the impairment/restructuring charges and the integration costs, net income and diluted earnings per common share for second quarter 2013 would have declined 8 percent and 10 percent, respectively, from a year ago, while net income and diluted earnings per common share for the first half of 2013 would have increased 2 percent and 1 percent, respectively. The declines for the second quarter of 2013 primarily reflect lower operating income driven principally by significantly reduced operating income in South America, which more than offset earnings growth in North America. A lower effective income tax rate and reduced financing costs partially offset the impacts of our operating income declines. The increases in net income and diluted earnings per common share for the first half of 2013 reflect a lower effective income tax rate and, to a lesser extent, reduced financing costs.

Net Sales. Second quarter 2013 net sales totaled $1.63 billion, relatively unchanged from second quarter 2012 net sales of $1.64 billion. Improved price/product mix of 5 percent was offset by a 3 percent volume decline and unfavorable currency translation of 2 percent due to weaker foreign currencies.

North American net sales for second quarter 2013 increased 3 percent to $977 million, from $950 million a year ago. This increase reflects improved price/product mix of 6 percent, which more than offset a 3 percent volume decline. In South America, second quarter 2013 net sales decreased 8 percent to $321 million from $349 million a year ago, as unfavorable currency translation of 7 percent coupled with a 6 percent volume reduction, more than offset a price/product mix improvement of 5 percent. The volume reduction primarily reflects weaker economic conditions, particularly in the Southern Cone of South America and in Brazil, and reduced sales to the brewing industry where excess industry capacity has weakened demand for high maltose in Brazil. Additionally, while price/product mix has improved, it was insufficient to allow us to fully recover increased corn, energy and labor costs through higher selling prices. Asia Pacific second quarter 2013 net sales declined 4 percent to $200 million from $208 million a year ago. The decrease reflects a 3 percent volume reduction and lower price/product mix of 2 percent, which more than offset a 1 percent benefit from favorable currency translation primarily attributable to stronger Asian currencies. The volume reduction reflects the effect of the fourth quarter 2012 sale of our investment in our Chinese non-wholly-owned consolidated subsidiary, Shouguang Golden Far East Modified Starch Co., Ltd. ("GFEMS"). Without second quarter 2012 net sales of $8 million from GFEMS, Asia Pacific net sales for second quarter 2013 would have been flat and volume would have increased approximately 1 percent from the year-ago period. EMEA net sales for second quarter 2013 grew 6 percent to $136 million from $128 million a year ago. This increase reflects a 7 percent price/product mix improvement and 3 percent volume growth, which more than offset unfavorable currency translation of 4 percent. Without a $2 million sales reduction attributable to the closure of our plant in Kenya, EMEA net sales for second quarter 2013 would have increased approximately 8 percent and volume would have grown approximately 5 percent from the prior year period.

First half 2013 net sales totaled $3.22 billion, relatively unchanged from $3.21 billion a year ago. Price/product mix improvement of 5 percent was offset by a 3 percent volume decline and unfavorable currency translation of 2 percent due to weaker foreign currencies.

Net sales in North America for the first half of 2013 increased 2 percent to $1.89 billion from $1.84 billion in the prior year period. This increase reflects improved price/product mix of 5 percent, which more than offset a 3 percent volume decline. In South America, first half 2013


net sales decreased 7 percent to $670 million from $717 million a year ago, as an 8 percent decline attributable to weaker foreign currencies and a 5 percent volume reduction more than offset a 6 percent price/product mix improvement. The volume reduction primarily reflects weaker economic conditions, particularly in the Southern Cone of South America and in Brazil, and reduced sales to the brewing industry where excess industry capacity has weakened demand for high maltose in Brazil. Additionally, while price/product mix has improved, it was insufficient to allow us to fully recover increased corn, energy and labor costs through higher selling prices, particularly during the second quarter. Asia Pacific first half 2013 net sales declined slightly to $396 million from $397 million a year ago, as a volume decline of 2 percent more than offset favorable currency translation of 1 percent and modest price/product mix improvement. The volume reduction reflects the effect of the fourth quarter 2012 sale of our investment in GFEMS. Without first half 2012 net sales of $13 million from GFEMS, Asia Pacific net sales for first half 2013 would have increased 3 percent and volume would have increased approximately 1 percent from a year ago. EMEA net sales for first half 2013 increased 5 percent to $265 million from $254 million a year ago. This increase reflects price/product mix improvement of 6 percent and 2 percent volume growth, which more than offset unfavorable currency translation of 3 percent. Without a $7 million sales reduction attributable to the closure of our plant in Kenya, EMEA net sales for first half 2013 would have increased approximately 8 percent and volume would have grown approximately 6 percent from the prior year period.

Cost of Sales and Operating Expenses. Cost of sales of $1.36 billion for the second quarter of 2013 increased 1 percent from $1.34 billion in the prior year period. Cost of sales of $2.64 billion for the first half of 2013 increased 1 percent from $2.62 billion a year ago. Higher raw material costs were substantially offset by reduced volume, the effects of currency translation and the impacts of continued cost savings focus. Currency translation caused cost of sales for both the second quarter and first half of 2013 to decrease approximately 2 percent from the prior year periods, reflecting the impact of weaker foreign currencies, particularly in South America. Gross corn costs per ton for the second quarter and first half of 2013 increased approximately 8 percent and 7 percent, respectively, from the comparable prior year periods, driven by higher market prices for corn. Our gross profit margin for the second quarter and first half of 2013 was 16.9 percent and 18.1 percent, respectively, compared to 18.1 percent and 18.4 percent last year.

Operating expenses for the second quarter and first half of 2013 increased to $139 million and $274 million, respectively, from $132 million and $268 million last year. These increases primarily reflect higher compensation-related costs, partially offset by the impact of weaker foreign currencies and the favorable impacts of our continued cost savings initiatives. Currency translation associated with the weaker foreign currencies caused operating expenses for the second quarter and first half of 2013 to decrease approximately 2 percent from the prior year periods. Operating expenses, as a percentage of net sales, were 8.5 percent for both the second quarter and first half of 2013, as compared to 8.0 percent and 8.3 percent, respectively, in the comparable prior year periods.

Operating Income. Second quarter 2013 operating income decreased 8 percent to $140 million from $153 million a year ago. The prior year period included a $10 million charge for impaired assets and restructuring costs in Kenya, $4 million of restructuring charges to reduce the carrying value of certain equipment in connection with our manufacturing optimization plan in North America and $1 million of costs pertaining to the integration of National Starch. Without the impairment, restructuring and integration costs, operating income for second quarter 2013 would have decreased 17 percent from $168 million a year ago. This decline primarily reflects significantly reduced operating income in South America, which more


than offset operating income growth in North America. Unfavorable currency translation due to weaker foreign currencies, particularly in South America, reduced operating income by approximately $2 million from the prior year period. North America operating income for second quarter 2013 increased 7 percent to $103.9 million from $96.9 million a year ago. The increase was driven by improved product selling prices and cost savings. South America operating income for second quarter 2013 decreased 63 percent to $17.3 million from $47.3 million a year ago. The decrease reflects significantly weaker results in the Southern Cone of South America and in Brazil. Our inability to increase selling prices to a level sufficient to recover higher local product costs, particularly in Argentina, and lower sales volumes due to soft demand from a weaker economy, drove the earnings decline. Additionally, a $4 million charge related to a fungus that impacted our stevia plants in Brazil contributed to the lower operating income. Translation effects associated with weaker South American currencies (particularly the Argentine Peso and Brazilian Real) caused operating income to decrease by approximately $2 million. We anticipate that our business in South America will continue to be challenged with high product costs, local currency devaluation, product pricing limitations and volume pressures for the remainder of the year. Asia Pacific operating income for second quarter 2013 increased 3 percent to $23.6 million from $22.9 million a year ago, primarily driven by improved volume and slightly favorable currency translation associated with stronger Asian currencies. EMEA operating income decreased 10 percent to $16.9 million from $18.8 million a year ago primarily reflecting higher local product and energy costs. Unfavorable currency translation associated with weaker foreign currencies also contributed to the lower operating results.

First half 2013 operating income was $315 million, up slightly from $314 million a year ago. The prior year period included a $10 million charge for impaired assets and restructuring costs in Kenya, $7 million of restructuring charges to reduce the carrying value of certain equipment in connection with our manufacturing optimization plan in North America and $4 million of costs pertaining to the integration of National Starch. Without the impairment, restructuring and integration costs, operating income for first half 2013 would have decreased 6 percent from $335 million a year ago, primarily reflecting reduced operating income in South America, which more than offset earnings growth in North America. Unfavorable currency translation associated with weaker foreign currencies caused operating income to decline by approximately $8 million from the prior year period. North America operating income for first half 2013 increased 7 percent to $211.6 million from $196.9 million a year ago. This increase primarily reflects improved product selling prices and cost savings. South America operating income for first half 2013 declined 35 percent to $60.6 million from $92.9 million a year ago. The decrease reflects significantly weaker results in the Southern Cone of South America and in Brazil, particularly during the second quarter of 2013. Our inability to increase selling prices to a level sufficient to recover higher local product costs, primarily in Argentina, and lower sales volumes due to soft demand from a weaker economy, drove the earnings decline. Additionally, a $4 million charge related to a fungus that impacted our stevia plants in Brazil contributed to the lower operating income. Translation effects associated with weaker South American currencies (particularly the Argentine Peso and Brazilian Real) caused operating income to decrease by approximately $7 million. We anticipate that our business in South America will continue to be challenged with high product costs, local currency devaluation, product pricing limitations and volume pressures for the remainder of the year. Asia Pacific operating income for first half 2013 grew 8 percent to $46.7 million from $43.2 million a year ago, driven by improved volume and higher product selling prices. Slightly favorable currency translation associated with stronger Asian currencies also contributed to the improved operating results. EMEA operating income decreased 4 percent to $36.2 million from $37.6 million a year ago. Improved product price/mix and volume growth largely offset the unfavorable impacts of higher local product and energy costs. Additionally, translation effects associated with weaker foreign currencies caused EMEA operating income to decrease by approximately $1 million.


Financing Costs-net. Financing costs for the second quarter and first half of 2013 declined to $16.3 million and $33.0 million, respectively, from $17.2 million and $36.7 million in the comparable prior year periods. These declines primarily reflect reduced interest expense driven by lower average borrowings and interest rates.

Provision for Income Taxes. Our effective income tax rate for the second quarter of 2013 was 21.9 percent compared to 18.4 percent a year ago. The effective income tax rate for the first six months of 2013 was 26.0 percent compared to 25.6 percent a year ago.

The second quarter of 2013 includes a favorable determination received from a Canadian court regarding the tax treatment of a prior period transaction, resulting in a discrete tax benefit of $5 million. The second quarter also includes the recognition of previously unrecognized tax benefits of approximately $3 million.

Our effective income tax rate for the second quarter of 2012 was favorably impacted by the recognition of the effects of a reversal of a $13 million valuation allowance that had been recorded against net deferred tax assets of our Korean subsidiary. The effective income tax rates for the 2012 periods also included the recognition of an income tax benefit of $6 million related to the $10 million pre-tax charge in Kenya and associated tax write-off of the investment. Without these items, our effective income tax rates for the second quarter and first half of 2012 would have been approximately 30 percent and 31 percent, respectively.

It is reasonably likely that approximately $3 million of previously unrecognized tax benefits will be recognized in the third quarter of 2013 as a result of a lapse of the statute of limitations.

Net Income Attributable to Non-controlling Interests. The net income attributable to non-controlling interests for second quarter and first half 2013 was $1.6 million and $2.9 million, respectively, consistent with the prior year periods.

Comprehensive Income (Loss) Attributable to Ingredion. We recorded a comprehensive loss of $3 million for the second quarter of 2013, as compared to comprehensive income of $75 million in the prior year period. The decrease primarily reflects a $57 million unfavorable variance in cash flow hedge activity. For the first half of 2013, we recorded comprehensive income of $66 million, as compared with $181 million a year ago. The decrease primarily reflects unfavorable variances related to currency translation and deferred losses on cash flow hedges of $69 million and $53 million, respectively. The unfavorable variances in the currency translation adjustment reflect a greater weakening in end of period foreign currencies relative to the US dollar in 2013, as compared to the year-ago periods.

Liquidity and Capital Resources

Cash provided by operating activities for the first six months of 2013 was $112 million. Our working capital increase for first half 2013 was driven principally by an increase in inventories reflecting higher raw material costs and increased period-end quantities, an increase in accounts receivable due to higher sales late in


the second quarter of 2013 as compared to 2012 and the timing of collections, and a decrease in accounts payable and accrued liabilities attributable to the timing of payments.

Capital expenditures of $132 million for the first six months of 2013 are in line with our capital spending plan for the year. We anticipate that our capital expenditures will be in the range of approximately $300 million to $350 million for full year 2013.

We have a senior, unsecured $1 billion revolving credit agreement (the "Revolving Credit Agreement") that matures on October 22, 2017. At June 30, 2013, there were no borrowings outstanding under our Revolving Credit Agreement. In addition to borrowing availability under our Revolving Credit Agreement, we also have approximately $483 million of unused operating lines of credit in the various foreign countries in which we operate.

At June 30, 2013, we had total debt outstanding of $1.81 billion, compared to $1.80 billion at December 31, 2012. The debt includes $350 million of 3.2 percent notes due 2015, $300 million (principal amount) of 1.8 percent senior notes due 2017, $200 million of 6.0 percent senior notes due 2017, $200 million of 5.62 percent senior notes due 2020, $400 million (principal amount) of 4.625 percent notes due 2020, $250 million (principal amount) of 6.625 percent senior notes due 2037 and $91 million of consolidated subsidiary debt consisting of local country short-term borrowings. The weighted average interest rate on our total indebtedness was approximately 4.3 percent for the first six months of 2013, down from 4.4 percent in the comparable prior-year period.

On May 15, 2013, our board of directors declared a quarterly cash dividend of $0.38 per share of common stock. This dividend was paid on July 25, 2013 to stockholders of record at the close of business on July 1, 2013.

We currently expect that our available cash balances, future cash flow from operations and borrowing capacity under our credit facilities will provide us with sufficient liquidity to fund our anticipated capital expenditures, dividends, and other investing and/or financing activities for the foreseeable future.

We have not provided federal and state income taxes on accumulated undistributed earnings of certain foreign subsidiaries because these earnings are determined to be permanently reinvested. It is not practicable to determine the amount of the unrecognized deferred tax liability related to the undistributed earnings. We do not anticipate the need to repatriate funds to the United States to satisfy domestic liquidity needs arising in the ordinary course of business, including liquidity needs associated with our domestic debt service requirements. Approximately $309 million of our cash and cash equivalents as of June 30, 2013 is held by our operations outside of the United States. We expect that available cash balances and credit facilities in the United States, along with cash generated from operations, will be sufficient to meet our operating and cash needs for the foreseeable future.

Hedging

We are exposed to market risk stemming from changes in commodity prices, foreign currency exchange rates and interest rates. In the normal course of business, we actively manage our exposure to these market risks by entering into various hedging transactions, authorized under established policies that place clear controls on these activities. These transactions utilize exchange-traded derivatives or over-the-counter derivatives with investment grade counterparties. Our hedging transactions may include, but are not limited to, a variety of


derivative financial instruments such as commodity futures, options and swap contracts, forward currency contracts and options, interest rate swap agreements and treasury lock agreements. See Note 5 of the Notes to the Condensed Consolidated Financial Statements for additional information.

Commodity Price Risk:

Our principal use of derivative financial instruments is to manage commodity price risk in North America relating to anticipated purchases of corn and natural gas to be used in the manufacturing process. We periodically enter into futures, options and swap contracts for a portion of our anticipated corn and natural gas usage, generally over the following twelve to eighteen months, in order to hedge price risk associated with fluctuations in market prices. These derivative instruments are recognized at fair value and have effectively reduced our exposure to changes in market prices for these commodities. We are unable to directly hedge price risk related to co-product sales; however, we enter into hedges of soybean oil (a competing product to our corn oil) in order to mitigate the price risk of corn oil sales. Unrealized gains and losses associated with marking our commodities-based derivative instruments to market are recorded as a component of other comprehensive income ("OCI"). At June 30, 2013, our accumulated other comprehensive loss account ("AOCI") included $42 million of losses, net of income taxes of $20 million, related to these derivative instruments. It is anticipated that approximately $39 million of these losses, net of income taxes of $19 million, will be reclassified into earnings during the next twelve months. We expect the losses to be offset by changes in the underlying commodities cost.

Foreign Currency Exchange Risk:

Due to our global operations, we are exposed to fluctuations in foreign currency exchange rates. As a result, we have exposure to translational foreign exchange risk when our foreign operation results are translated to US dollars and to transactional foreign exchange risk when transactions not denominated in the functional currency of the operating unit are revalued. We primarily use foreign currency forward contracts, swaps and options to selectively hedge our foreign currency transactional exposures. We generally hedge these exposures up to twelve months forward. At June 30, 2013, we had foreign currency forward sales contracts with an aggregate notional amount of $440 million and foreign currency forward purchase contracts with an aggregate notional amount of $87 million that hedged transactional exposures. The fair value of these derivative instruments is an asset of $2 million at June 30, 2013.

Interest Rate Risk:

We occasionally use interest rate swaps and Treasury Lock agreements ("T-Locks") to hedge our exposure to interest rate changes, to reduce the volatility of our financing costs, or to achieve a desired proportion of fixed versus floating rate debt, based on current and projected market conditions. At June 30, 2013, we did not have any T-Locks outstanding. We have interest rate swap agreements that effectively convert the interest rate on our 3.2 percent $350 million senior notes due November 1, 2015 to a variable rate. These swap agreements call for us to receive interest at a fixed rate (3.2 percent) and to pay interest at a variable rate based on the six-month US dollar LIBOR rate plus a spread. We have designated these interest rate swap agreements as hedges of the changes in fair value of the underlying debt obligation attributable to changes in interest rates and account for them as fair value hedges. The fair value of these interest rate swap agreements is $15 million at June 30, 2013 and is reflected in the Condensed Consolidated Balance Sheet within other non-current assets,


with an offsetting amount recorded in long-term debt to adjust the carrying amount of the hedged debt obligation.

At June 30, 2013, AOCI included $9 million of losses (net of income taxes of $6 million) related to settled T-Locks. These deferred losses are being amortized to financing costs over the terms of the senior notes with which they are associated. It is anticipated that $2 million of these losses (net of income taxes of $1 million) will be reclassified into earnings during the next twelve months.

Critical Accounting Policies and Estimates

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