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PENX > SEC Filings for PENX > Form 10-Q on 9-Apr-2014All Recent SEC Filings

Show all filings for PENFORD CORP

Form 10-Q for PENFORD CORP


9-Apr-2014

Quarterly Report


Item 2: Management's Discussion and Analysis of Financial Condition and
Results of 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 10 to the Condensed Consolidated Financial Statements for additional information regarding the Company's business segment operations.

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.

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

Consolidated sales decreased 3.6% to $106.1 million in the second quarter of fiscal 2014 from $110.1 million for the quarter ended February 28, 2013. Consolidated sales for the six months ended February 28, 2014 decreased 5.6% to $215.4 million compared to consolidated sales of $228.1 million for the same period a year ago.

The decline in sales for the three and six months ended February 28, 2014 was primarily due to lower average unit selling pricing in the Industrial Ingredients segment, partially offset by volume growth in both business segments. The decline in Industrial Ingredients pricing was due to the decrease in corn costs as discussed below.

Consolidated gross margin as a percent of sales for the second quarter of fiscal 2014 was 11.5% compared to 10.0% a year ago. Consolidated gross margin as a percent of sales for the first half of fiscal 2014 of 10.6% was comparable to the same period a year ago.

Bank debt outstanding at February 28, 2014 was down $4.7 million from August 31, 2013.

The Company amended its pension plan for salaried employees to eliminate benefit accruals effective March 1, 2014.

On March 25, 2014, the Company acquired the net assets of Gum Technology for $10.2 million in cash, subject to working capital and certain other adjustments.

Industrial Ingredients

Second quarter fiscal 2014 sales at the Company's Industrial Ingredients business unit decreased $7.7 million, or 9.2%, to $75.8 million from $83.5 million during the second quarter of fiscal 2013. This decrease was primarily due to:

Industrial starch sales in the three months ended February 28, 2014 of $36.9 million were down 16.5% compared to last year's second quarter sales of $44.2 million. The decline in sales was primarily driven by lower unit pricing as the market price of corn continued to decrease and a decline in the corn costs passed through to customers. Volume declined approximately 3%.

Ethanol sales increased $4.8 million, or 26.4%, to $23.0 million from $18.2 million on a 34% increase in volume partially offset by a 6% decline in average unit selling price per gallon.

Sales of by-products declined 24.4% to $15.9 million from $21.0 million a year ago on a decrease in average unit selling prices. Selling prices of corn by-products declined 30% as the cost of corn decreased with the new crop harvest. The sales volume was 8% higher than the previous year's second quarter.


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First half fiscal 2014 sales at the Company's Industrial Ingredients business unit decreased $17.4 million, or 10.0%, to $156.4 million from $173.8 million last year. This decrease was primarily due to:

Industrial starch sales in the six months ended February 28, 2014 of $80.5 million decreased $7.5 million from $88.0 million in the first half of fiscal 2013. The decline in sales was driven by lower average unit pricing caused by a decrease in the corn costs passed through to customers.

Ethanol sales increased $3.4 million, or 8.2%, to $45.0 million from $41.6 million on an 18% increase in volume, partially offset by an 8% decline in average unit selling price per gallon.

Sales of by-products declined 30.2% to $30.9 million from $44.2 million a year ago on a decrease in average unit selling prices. Selling prices of corn by-products declined 33% as the cost of corn decreased. Sales volume was 4% higher than last year.

Industrial Ingredients' operating income in the second quarter of fiscal 2014 was approximately breakeven compared with an operating loss of $0.5 million in the second quarter last year due to an improvement in gross margin. Gross margin increased $0.5 million to $3.4 million from $2.9 million the previous year. Margin improvement was due to (1) increased sales volume of $1.9 million and
(2) lower corn costs of $2.6 million, partially offset by (3) lower average unit selling prices of $1.2 million due to the decline in corn costs, (4) higher energy costs of $1.4 million, (5) higher maintenance and distribution costs of $1.3 million due to the harsh winter conditions, and (6) an increase in other manufacturing costs of $0.1 million.

Industrial Ingredients' loss from operations for the six months ended February 28, 2014 was $2.0 million, a decline of $2.9 million from operating income of $0.9 million in the first six months of fiscal 2013. Gross margin in the first half of fiscal 2014 decreased $3.2 million to $4.8 million. The effect of higher sales volume of $2.2 million was offset by lower average unit pricing of $3.2 million. Also contributing to the margin contraction were higher energy costs of $1.6 million, higher maintenance and distribution costs of $1.7 million and other manufacturing cost increases of $0.4 million, partially offset by lower corn costs of $1.5 million. Energy, maintenance and distribution cost increases were primarily due to harsh winter conditions in the second quarter. Operating expenses decreased $0.3 million due to lower employee costs.

Food Ingredients

Fiscal 2014 second quarter sales for the Food Ingredients segment of $30.3 million increased 13.8%, or $3.7 million, over the second quarter of fiscal 2013. Higher sales volume contributed $4.9 million to the sales increase, partially offset by product mix and pricing changes of $1.2 million. Sales of coating applications, which contributed 30% of total revenue in the quarter, improved 6% on an increase in volume of 11%, partially offset by a decrease in average unit pricing of 4%. Sales of other applications, including sales to the pet treats and soups/sauces/gravies end markets, expanded 17%, and accounted for 85% of the sales growth in the second quarter.

Year-to-date fiscal 2014 sales increased $4.7 million, or 8.6%, to $58.9 million from $54.3 million in the first six months of fiscal 2013. Sales volume improved 11%, contributing $5.9 million to sales growth, while average unit pricing declined 2%, or $1.2 million. Sales of coating applications in the six months ended February 28, 2014 were comparable to sales of coating applications for the same period last year. Sales of other applications, including sales to the pet treats, gluten free and soups/sauces/gravies end markets, expanded 13% and accounted for all of the sales growth in the first half of fiscal 2014.

Operating income for the second quarter of fiscal 2014 at the Company's Food Ingredients segment increased 4.7% to $5.8 million from $5.5 million in the same period last year primarily due to an increase in gross margin of $0.7 million. Gross margin of $8.8 million improved $0.7 million due to an increase in volume of $1.5 million, partially offset by an increase in raw material costs of $0.8 million. Operating and research and development expenses increased $0.4 million on higher employee costs.

Operating income for the first six months of fiscal 2014 increased 13.2%, or $1.4 million, to $12.3 million from $10.9 million in the same period last year primarily due to an increase in gross margin of $1.9 million. Gross margin improved due to improved sales volume of $1.7 million and higher manufacturing yields and lower manufacturing costs of $1.1 million, partially offset by higher raw material costs of $0.9 million. Operating expenses increased $0.5 million on additional employee costs.


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Corporate Operating Expenses

Corporate operating expenses for the three and six month periods ended February 28, 2014 increased $0.4 million and $0.5 million, respectively, due to increases in professional and audit fees.

Pension Expense

In January 2014, the Company amended the defined benefit pension plan for salaried employees (the "Plan") to cease the accrual of benefits under the Plan effective March 1, 2014. The Company anticipates that there will be no gain or loss recorded in the Statement of Operations as a result of the Plan curtailment.

Interest Expense

Interest expense decreased $0.2 million compared to the second quarter last year due to a decrease in the average debt outstanding. Average outstanding bank debt was about $16 million lower in the second quarter of fiscal 2014 than in the same period a year ago.

Income Taxes

The Company's effective tax rates for the three- and six-month periods ended February 28, 2014 were 41.0% and 41.2%, respectively. The difference between the effective tax rates and the U.S. federal statutory rate was due to state income taxes and the effect of additions to the liability for uncertain tax positions described in Note 5 to the Condensed Consolidated Financial Statements.

The Company's effective tax rates for the three- and six-month periods ended February 28, 2013 were 27.0% and 34.2%, 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%, respectively, for the three- and six-month periods ended February 28, 2013.

The tax valuation allowance at February 28, 2014 of $1.7 million was related primarily to the small ethanol producer tax credit carryforwards in the United States. Tax laws in the U.S. require that any net operating loss carryforwards be utilized before the Company can utilize the small ethanol producer tax credit carryforwards. Due to the expiration of the small ethanol producer tax credit carryforward period in 2014, the Company does not believe it has sufficient positive evidence to substantiate that the small ethanol producer tax credit carryforwards are realizable at a more-likely-than-not level of assurance.

In the second quarter of fiscal 2014, the Company liquidated its Australian subsidiaries and received approval from the Australian tax authorities for the liquidation. As of August 31, 2013, the Company had provided a tax valuation allowance of $10.9 million against the entire Australian net deferred tax asset. During the quarter ended February 28, 2014, as a result of the liquidation, the previously recorded deferred tax asset and corresponding valuation allowance were reversed resulting in no net effect on current or deferred income taxes.

At February 28, 2014, the Company had $5.6 million of net U. S. 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, 2014. 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.


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Acquisition

As discussed in Note 13 to the Condensed Consolidated Financial Statements, on March 25, 2014, the Company acquired the net assets of Gum Technology ("Seller") for $10.2 million in cash, subject to working capital and certain other adjustments. The funding of the purchase price was provided by borrowings under the Company's credit facility. In connection with the acquisition, $750,000 of the purchase price ("Holdback") has been retained by the Company as a fund to satisfy certain of the Seller's post-closing obligations. The Holdback is payable to the Seller, net of amounts applied to satisfy the obligations of the Seller, within twelve months of the date of the acquisition.

The Company entered into compensatory stock option agreements outside of the Company's 2006 Incentive Plan with three key former employees of the Seller. Pursuant to these agreements, the Company granted options to purchase an aggregate of 45,000 shares of the Company's common stock at an exercise price equal to the closing price as of the close of business on March 25, 2014. These options have a term of seven years and vest ratably over a three-year period.

Gum Technology, based in Tucson, Arizona, distributes and blends gums and hydrocolloids, serving primarily the food and beverage industries in North America and Asia. Gum Technology specializes in developing and producing customized stabilizers to meet customers' product formulation needs. This acquisition will broaden the Company's food ingredients portfolio of functional and specialty ingredient systems within the Food Ingredients segment.

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 $8.4 million for the six months ended February 28, 2014 compared with $3.4 million for the same period last year. The increase in operating cash flow was due to a decrease in working capital requirements.

Investing Activities

Cash used in investing activities of $5.5 million was primarily for investments in capital projects. See Note 3 to the Condensed Consolidated Financial Statements. The Company expects total capital expenditures for fiscal 2014 to be approximately $17 million.

Financing Activities

As of February 28, 2014, the Company had $66.9 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).

As of February 28, 2014, the 2012 Agreement provided that the Total Leverage Ratio shall not exceed 3.25 through May 31, 2014 and 3.0 thereafter. The Company must also 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 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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Effective March 21, 2014, in connection with the acquisition of substantially all of the net assets of Gum Technology, the Company amended the 2012 Agreement to adjust certain financial covenants. The Total Leverage Ratio, as defined in the 2012 Agreement, shall not exceed 4.25 on May 31, 2014, 3.50 on August 31, 2014 and 3.00 at the end of each quarter thereafter. In addition, the Company's maximum annual capital expenditures was increased to $17.5 million from $15.0 million for fiscal 2014.

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, 2014, the Company was not permitted to pay dividends.

Contractual Obligations

The Company is a party to various debt and lease agreements at February 28, 2014 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, 2013.

Off-Balance Sheet Arrangements

The Company had no off-balance sheet arrangements at February 28, 2014.

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 for the fiscal year ended August 31, 2013 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 ("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 for the year ended August 31, 2013, which include but are not limited to:

competition;


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

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;

other unforeseen developments in the industries in which Penford operates,

the Company's ability to successfully operate under and comply with the terms of its bank credit agreement, as amended; and

other factors described in the Company's Form 10-K Part I, Item 1A "Risk Factors."

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