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."
In March 2014, the Company acquired substantially all of the net assets and
operations of Gum Technology ("Seller") for a purchase price of $9.9 million,
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 has been
retained by the Company as a fund to satisfy certain of the Seller's
post-closing obligations. The net assets, consisting primarily of intangible
assets, and results of operations are included in the balance sheet and results
of operations of the Company's Food Ingredients segment. 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.
Results of Operations
• Consolidated sales decreased 1.9% to $119.4 million in the third quarter
of fiscal 2014 from $121.7 million for the quarter ended May 31, 2013.
Consolidated sales for the nine months ended May 31, 2014 decreased 4.3%
to $334.8 million compared to consolidated sales of $349.8 million for the
same period a year ago.
• The decline in sales for the three and nine months ended May 31, 2014 was
primarily due to lower average unit pricing in the Industrial Ingredients
segment, partially offset by volume growth in the Food Ingredients
segment. 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 third quarter of
fiscal 2014 was 12.4% compared to 10.8% a year ago. Consolidated gross
margin as a percent of sales for the first nine months of fiscal 2014 was
11.3% compared to 10.7% in the same period last year.
• The Company amended one of its pension plans to eliminate benefit
accruals. Pension expense for the third quarter of fiscal 2014 decreased
by $0.4 million due to the amendment. See Note 8 to the Condensed
Consolidated Financial Statements.
• The Company recorded $1.0 million in non-operating income to reflect the
forgiveness of a loan from an agency of the State of Iowa. See Note 4 to
the Condensed Consolidated Financial Statements.
• On March 25, 2014, the Company acquired the substantially all of the net
assets of Gum Technology for a purchase price of $9.9 million, subject to
working capital and certain other adjustments. The acquisition was funded
by borrowings on the Company's credit facility. See Note 13 to the
Condensed Consolidated Financial Statements.
Third quarter fiscal 2014 sales at the Company's Industrial Ingredients business
unit decreased $9.1 million
, or 9.7%, to $84.1 million
from $93.2 million
the third quarter of fiscal 2013. This decrease was primarily due to:
• Industrial starch sales in the three months ended May 31, 2014 of $39.7
million were down 10.9% compared to last year's third quarter sales of
$44.6 million. The decline in sales was primarily driven by lower unit
pricing as the market price of corn continued to decrease causing a
decline in the corn costs passed through to customers in revenue. Volume
improved approximately 5.2%.
• Ethanol sales of $28.0 million were comparable to the prior year third
quarter. A 4.8% increase in average unit selling price per gallon was
offset by a 4.5% decline in volume.
• Sales of corn-based by-products declined 19.8% to $16.4 million from $20.5
million a year ago on a decrease in average unit selling prices.
Sales for the nine months ended May 31, 2014
at the Company's Industrial
Ingredients business unit decreased $26.5 million
, or 9.9%, to $240.5 million
from $267.0 million
last year. This increase was primarily due to:
• Industrial starch sales in the nine months ended May 31, 2014 of $120.3
million decreased $12.3 million from $132.6 million in the same period 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 $3.3 million, or 4.7%, to $73.0 million from $69.7
million on a 9.3% increase in volume, partially offset by a 3.8% decline
in average unit selling price per gallon.
• Sales of by-products declined 26.9% to $47.3 million from $64.7 million a
year ago primarily due to a decrease in average unit selling prices.
Selling prices of corn by-products declined 28.6% as the cost of corn
decreased. Sales volume increased 2.4% from last year.
Industrial Ingredients' operating income in the third quarter of fiscal 2014 of
grew $1.4 million
over the previous year's third quarter primarily
due to an improvement in gross margin. Gross margin increased $1.2 million
from $4.1 million
the previous year. Margin improvement was due to
favorable pricing and mix of $0.5 million
and lower corn costs of $3.5 million
partially offset by higher energy costs of $2.2 million
, higher maintenance and
distribution costs of $0.4 million
and an increase in other manufacturing costs
of $0.2 million
. Operating and research and development expenses decreased $0.2
on lower benefit costs.
During the third quarter of fiscal year 2014, the Company changed its estimates
for useful lives of certain machinery and equipment used by the Industrial
Ingredients segment to better match depreciation expense of these assets with
the periods in which these assets are expected to generate revenue. The new
estimated useful lives were established based on manufacturing engineering data
and external benchmark data and were generally increased as compared to the
previous estimates. The Company accounted for this as a prospective change in
accounting estimate as of May 1, 2014
, thereby impacting the current quarter and
future periods. The change in the estimate lowered depreciation expense as
compared to the amount that would have been recorded using the historical
estimated useful lives. The effect of this change on Industrial Ingredient's
third quarter 2014 operating income was $0.2 million
. The Company expects, based
on its current level of operations and investment in property, plant and
equipment, that this change in the estimated useful lives of these assets will
increase operating income in the fourth quarter of fiscal year 2014 by
approximately $1.0 million
, and, on an annualized basis, in the range of
approximately $4.4 million
to $4.6 million
Industrial Ingredients' loss from operations for the nine months ended May 31,
was $0.1 million
, a decline of $1.6 million
from operating income of $1.5
in the first nine months of fiscal 2013. Year-to-date fiscal 2014 gross
margin of $10.1 million
decreased $2.1 million
from gross margin of $12.2
a year ago. The effect of higher sales volume of $1.5 million
by lower average unit pricing of $1.9 million
. Also contributing to the margin
contraction were higher energy costs of $3.8 million
, higher maintenance and
distribution costs of $2.0 million
and other manufacturing cost increases of
, partially offset by lower corn costs of $4.5 million
maintenance and distribution cost increases were primarily due to harsh winter
conditions in the second quarter of fiscal 2014. Operating expenses decreased
due to lower employee costs.
Fiscal 2014 third quarter sales for the Food Ingredients segment of $35.3
increased 23.8%, or $6.8 million
, over the third quarter of fiscal 2013.
The addition of Gum Technology revenue contributed $2.1 million
to the sales
increase. Sales of coating applications, which contributed 27% of segment
revenue in the quarter, improved 2.5% on an increase in volume of 5.0%,
partially offset by a decrease in average unit pricing of 2.4%. Sales of other
applications, including sales to the pet treats, protein and dairy end markets,
Year-to-date fiscal 2014 sales increased $11.5 million
, or 13.8%, to $94.2
from $82.8 million
in the first nine months of fiscal 2013. The
acquisition of Gum Technology added $2.1 million
to 2014 year-to-date revenue
growth. Excluding Gum Technology, sales improved 11.2% on sales volume growth.
Sales of coating applications in the nine months ended May 31, 2014
comparable to sales of coating applications for the same period last year. Sales
of other end market applications, including sales to the pet treats and dairy
end markets, expanded 16.7% on volume increases of 21.3% offset by lower unit
pricing of 3.7%.
Operating income for the third quarter of fiscal 2014 at the Company's Food
Ingredients segment decreased 2.9% to $6.0 million
from $6.2 million
in the same
period last year due to an increase in gross margin of $0.5 million
offset by an
increase in operating and research and development expenses of $0.7 million
Gross margin of $9.6 million
improved due to an increase in volume of $2.1
, partially offset by an increase in raw material and manufacturing costs
of $1.6 million
. Operating and research and development expenses increased due
to the addition of Gum Technology employees, as well as additional lease costs
for new office and research laboratories in Colorado
Operating income for the first nine months of fiscal 2014 increased 7.3%, or
, to $18.3 million
from $17.1 million
in the same period last year
primarily due to an increase in gross margin of $2.4 million
. Gross margin
improved due to the effect of improved sales of $3.5 million
, partially offset
by higher raw material and other manufacturing costs of $1.1 million
expenses increased $1.1 million
due to the acquisition of Gum Technology,
additional employee costs and higher lease costs for facilities in Colorado
Corporate Operating Expenses
Corporate operating expenses for the three- and nine-month periods ended May 31,
increased $0.6 million
and $1.0 million
, respectively, due to increases in
professional and audit fees and higher employee costs.
In early 2014, the Company amended its Penford Corporation Retirement Plan,
which is a defined benefit pension plan for certain salaried and other employees
(the "Retirement Plan") to cease the further accrual of participant benefits. As
a result of the amendment to the Retirement Plan, the Company performed a
remeasurement of the Retirement Plan's pension benefit liability and the net
periodic benefit cost. The discount rate for the remeasurement of the pension
liability decreased from 5.24% as of August 31, 2013
to 4.91%. There was no
change in the expected return on assets. Pension net periodic benefit cost
decreased $0.4 million
in the third quarter of fiscal 2014 as a result of the
curtailment and the Company expects an additional $0.4 million
in pension cost
savings in the fourth quarter of fiscal 2014. The Company cannot estimate the
effect the curtailment will have on net periodic benefit cost beyond fiscal
Interest expense for the third quarter of fiscal 2014 was comparable to the same
period a year ago. Interest expense for the nine months ended May 31, 2014
decreased $0.5 million
compared to the comparable period last year due to a
decrease in the average debt outstanding.
The Company's effective tax rates for the three- and nine-month periods ended
May 31, 2014
were 38.6% and 39.6%, respectively. The difference between the
effective tax rates and the U.S. federal statutory rate was primarily due to
state income taxes.
The tax valuation allowance at May 31, 2014
of $1.8 million
primarily to the small ethanol producer tax credit carryforwards in the United
. 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 second quarter fiscal 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 May 31, 2014
, the Company had $1.8 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
May 31, 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.
As discussed in Note 13 to the Condensed Consolidated Financial Statements, on
March 25, 2014
, the Company acquired the net assets of Gum Technology for a
purchase price of $9.9 million
, subject to working capital and certain other
adjustments. The Condensed Consolidated Financial Statements reflect the Gum
Technology financial position at May 31, 2014
and the results of operations
since acquisition in the Food Ingredients segment.
Gum Technology, based in Tucson, Arizona
, distributes and blends gums and
hydrocolloids, serving primarily the food and beverage industries in North
. 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.
Recent Accounting Pronouncements
On May 28, 2014
, the FASB issued guidance that requires an entity to recognize
the amount of revenue to which it expects to be entitled for the transfer of
promised goods or services to customers. The guidance will replace most existing
revenue recognition guidance when it becomes effective. The new standard is
effective for the Company on September 1, 2017
and early application is not
permitted. The standard permits the use of either the retrospective or
cumulative effect transition method. The Company is evaluating the effect that
this new guidance will have on its consolidated financial statements and related
disclosures. The Company has not selected a transition method nor has it
determined the effect of the standard on its ongoing financial reporting.
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.
Cash provided by operations was $11.3 million
for the nine months ended May 31,
compared with $14.6 million
for the same period last year. The decrease in
operating cash flow was due to an increase in working capital requirements.
The increase in cash used in investing activities of $11.2 million
due to the acquisition of Gum Technology in March 2014
. See Note 13 to the
Consolidated Condensed Financial Statements.
Net cash provided from financing activities was $6.2 million
for the nine months
ended May 31, 2014
, primarily from borrowings on the Company's revolving credit
facility used to acquire Gum Technology. As of May 31, 2014
, the Company had
outstanding on its $130 million
secured revolving credit facility
(as amended, 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 the London Interbank Offered Rate ("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 can range
between 2% and 4%, depending upon the ratio of the Company's funded debt to
earnings before interest, taxes, depreciation and amortization (defined in the
2012 Agreement as the "Total Leverage Ratio").
The 2012 Agreement provides that the Total Leverage Ratio shall not exceed 4.25
on May 31, 2014
, 3.50 on August 31, 2014
and 3.0 at the end of each quarter
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
for fiscal 2014)
if the Total Leverage Ratio is greater than 2.50 for the last two consecutive
fiscal quarters. The Company's obligations under the 2012 Agreement are secured
by substantially all of the Company's assets.
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 May 31, 2014
, the Company was not permitted to pay dividends.
The Company is a party to various debt and lease agreements at May 31, 2014
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
except as described
In the third quarter of fiscal 2014, the Company entered into new leases for
additional office space and research laboratories. The future minimum lease
payments for new noncancelable operating leases are as follows:
2014 $ 170
2019 & thereafter 4,098
Off-Balance Sheet Arrangements
The Company had no off-balance sheet arrangements at May 31, 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. See Note 2 to the Condensed Consolidated Financial
Statements for the change in estimate in the third quarter of fiscal 2014.
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,
, which include but are not limited to:
• 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