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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

 


 

FORM 10-K

 

FOR ANNUAL AND TRANSITION REPORTS

 

PURSUANT TO SECTIONS 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934

 

(Mark One)

 

x      ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the fiscal year ended June 30, 2010

 

OR

 

o         TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the transition period from            to            

 

Commission file number   0-17196

 

MGP Ingredients, Inc.

(Exact Name of Registrant as Specified in Its Charter)

 

Kansas

 

48-0531200

(State or Other Jurisdiction

 

(I.R.S. Employer

of Incorporation or Organization)

 

Identification No.)

 

 

 

100 Commercial Street, Box 130, Atchison, Kansas

 

66002

(Address of Principal Executive Offices)

 

(Zip Code)

 

Registrant’s telephone number, including area code (913) 367-1480

 

Securities registered pursuant to Section 12(b) of the Act:

 

Title of Each Class

 

Name of Each Exchange on Which Registered

NONE

 

 

 

Securities registered pursuant to Section 12(b) of the Act:

 

Title of Each Class

 

Name of Each Exchange on Which Registered

Common Stock, no par value

 

NASDAQ Global Select Market

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes o No x

 

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.  Yes o  No x

 

Indicate by check mark whether the registrant:  (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes x  No o

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes o  No o

 

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to their Form 10-K.  o

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company.  See definition of “accelerated filer, “large accelerated filer” and smaller company: in Rule 12b-2 of the Exchange Act. (Check One):

 

Large accelerated filer o

 

Accelerated filer x

 

 

 

Non-accelerated filer o

 

Smaller reporting company x

 

Indicate by checkmark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes  o  No  x

 

The aggregate market value of common equity held by non-affiliates, computed by reference to the last sales price as reported by NASDAQ on December 31, 2009, was $89,957,872.

 

The number of shares of the registrant’s common stock outstanding as of August 31, 2010 was 17,814,714.

 

DOCUMENTS INCORPORATED BY REFERENCE

 

The following documents are incorporated herein by reference:

 

(1)                                 Portions of the MGP Ingredients, Inc. Proxy Statement for the Annual Meeting of Stockholders to be held on October 21, 2010 are incorporated by reference into Part III of this report to the extent set forth herein.

 

 

 



Table of Contents

 

CONTENTS PAGE

 

 

Forward Looking Statements

iii

 

Available Information

iii

 

 

 

 

PART I

 

 

 

 

Item 1.

Business

1

 

 

General Information

1

 

 

Fiscal 2010 Developments

2

 

 

Financial Information About Segments

3

 

 

Business Strategy

3

 

 

Product Sales

4

 

 

Ingredient Solutions Segment

5

 

 

Distillery Products Segment

7

 

 

Other Segment

9

 

 

Patents

10

 

 

Research and Development

10

 

 

Seasonality

10

 

 

Transportation

. 10

 

 

Raw Materials

10

 

 

Energy

11

 

 

Employees

11

 

 

Regulation

12

 

 

Joint Ventures

13

 

Item 1A.

Risk Factors

15

 

Item 1B.

Unresolved Staff Comments

21

 

Item 2.

Properties

21

 

Item 3.

Legal Proceedings

22

 

Item 4.

(Removed and Reserved)

22

 

Item 4A.

Executive Officers of the Registrant

23

 

 

 

 

PART II

 

 

 

 

Item 5.

Market for Registrant’s Common Equity, Related Stockholders Matters and Issuer Purchases of Equity Securities

25

 

 

Trading Market

25

 

 

Historical Stock Prices

25

 

 

Record Holders

25

 

 

Trading Volumes

25

 

 

Dividends

25

 

 

Purchases of Equity Securities by Issuer

26

 

Item 6.

Selected Financial Data

27

 

Item 7.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

29

 

 

General

29

 

 

Critical Accounting Policies

31

 

 

Developments in the Ingredient Solutions Segment

33

 

 

Developments in the Distillery Products Segment

33

 

 

Developments in the Other Segment

33

 

 

Segment Results

34

 

 

Fiscal 2010 Compared to Fiscal 2009

35

 

 

Quarterly Financial Information

41

 

 

Liquidity and Capital Resources

41

 

 

Off Balance Sheet Obligations

48

 

 

New Accounting Pronouncements

49

 

Item 7A.

Quantitative and Qualitative Disclosure About Market Risk

50

 

Item 8.

Financial Statements and Supplementary Data

51

 

 

Management’s Report on Internal Control Over Financial Reporting

51

 

 

Report of Independent Registered Public Accounting Firm

51

 

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Consolidated Statements of Operations — Years Ended June 30, 2010 and June 30, 2009

53

 

 

Consolidated Balance Sheets — June 30, 2010 and June 30, 2009

54

 

 

Consolidated Statements of Cash Flows — Years Ended June 30, 2010 and June 30, 2009

55

 

 

Consolidated Statements of Changes in Stockholders’ Equity and Comprehensive Income (Loss) — Years Ended June 30, 2010 and June 30, 2009

56

 

 

Notes to Consolidated Financial Statements — Years Ended June 30, 2010 and June 30, 2009

57

 

Item 9.

Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

95

 

Item 9A

Controls and Procedures

95

 

Item 9B.

Other Information

96

 

 

 

 

PART III

 

 

 

Item 10.

Directors and Corporate Governance

97

 

Item 11.

Executive Compensation

97

 

Item 12.

Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

97

 

Item 13.

Certain Relationships and Related Transactions, and Director Independence

98

 

Item 14.

Principal Accountant Fees and Services

98

 

 

 

 

PART IV

 

 

 

Item 15.

Exhibits and Financial Statement Schedules

99

 

 

 

 

SIGNATURES

110

 

The calculation of the aggregate market value of the Common Stock held by non-affiliates is based on the assumption that non-affiliates do not include directors or executive officers. Such assumption does not constitute an admission by the Company or any director or executive officer that any director or executive officer is an affiliate of the Company.

 

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FORWARD-LOOKING STATEMENTS

 

This report contains forward-looking statements as well as historical information.  All statements, other than statements of historical facts, included in this Annual Report on Form 10-K regarding the prospects of our industry and our prospects, plans, financial position and business strategy may constitute forward-looking statements.  In addition, forward-looking statements are usually identified by or are associated with such words as “intend,” “plan”, “believe,” “estimate,” “expect,” “anticipate,” “hopeful,” “should,” “may,” “will”, “could”, “encouraged”, “opportunities”, “potential” and/or the negatives of these terms or variations of them or similar terminology.  They reflect management’s current beliefs and estimates of future economic circumstances, industry conditions, Company performance and financial results and are not guarantees of future performance.  All such forward-looking statements are subject to certain risks and uncertainties that could cause actual results to differ materially from those contemplated by the relevant forward-looking statement.  Important factors that could cause actual results to differ materially from our expectations include, among others: (i) disruptions in operations at our Atchison facility,  (ii) the availability and cost of grain and fluctuations in energy costs, (iii) the effectiveness of our hedging strategy, (iv) the competitive environment and related market conditions, (v) the ability to effectively operate the Illinois Corn Processing, LLC (“ICP”) joint venture, (vi) our ability to maintain compliance with all applicable loan agreement covenants, (vii) our ability to realize operating efficiencies, (viii) and actions of governments.    For further information on these and other risks and uncertainties that may affect our business, see Item 1A. Risk Factors.

 

AVAILABLE INFORMATION

 

We make available through our web site (www.mgpingredients.com) under “Investors — Investor Relations,” free of charge, our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to those reports as soon as reasonably practicable after we electronically file or furnish such material with the Securities and Exchange Commission.

 

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PART I

 

Throughout this document, Dollars are presented in thousands unless otherwise noted.

 

ITEM 1.  BUSINESS

 

As used herein, unless the context otherwise requires, the terms “Company”, “we”, “us”, “our” and words of similar import refers to the combined business of MGP Ingredients, Inc. and its consolidated subsidiaries.

 

GENERAL INFORMATION

 

MGP Ingredients, Inc. is a Kansas corporation headquartered in Atchison, Kansas.  It was incorporated in 1957 and is the successor to a business founded in 1941 by Cloud L. Cray, Sr.

 

The Company produces certain ingredients and distillery products which are derived from wheat flour and corn, respectively, primarily to serve the packaged goods industry.  The Company has three reportable segments:  ingredient solutions, distillery products and other.  Our ingredient solutions segment products primarily consist of specialty starches, specialty proteins, commodity starches and commodity vital wheat gluten.  Mill by-products, consisting primarily of mill feeds or “midds,” had also previously been included in this segment but were discontinued with the shutdown of our wheat flour milling operations at the Atchison, Kansas plant in the second quarter of fiscal 2009.  The distillery products segment consists of food grade alcohol, along with a minimal amount of fuel grade alcohol, commonly known as ethanol, and distillers feed, which are co-products of our distillery operations.  Our other segment products are comprised of plant-based polymers and wood-based composite resins manufactured through the further processing of certain of our starches and proteins and wood particles.  Prior to the sale of our Kansas City, Kansas facility described below, our other segment also included pet-related products primarily consisting of extruded plant-based resins and finished pet treats.

 

We purchase corn obtained from or through grain elevators.  We purchase wheat flour, the principal raw material used in the manufacture of our protein and starch products, from ConAgra Mills.   We process flour with water to extract vital wheat gluten, the basic protein component of flour, which we use primarily to process into specialty wheat proteins that possess increased protein levels and/or enhanced functional characteristics.  Most wheat protein products are dried into powder and sold in packaged or bulk form.  We further process the starch slurry which results after the extraction of the protein component to extract premium wheat starch, a portion of which we further  process into specialty starches and a portion of which we sell as commodity starch, and all of which we dry into powder and sell in packaged or bulk form.  We mix the remaining starch slurry with corn and water and then cook, ferment and distill it into alcohol.  We dry the residue of the distilling operations and sell it as a high protein additive for animal feed.

 

The principal location at which we make our products as of June 30, 2010 is our plant located in Atchison, Kansas. We also operate a facility in Onaga, Kansas for the production of plant-based biopolymers and wood composite resins. Our line of textured wheat proteins are produced through a toll manufacturing arrangement at a facility in Kansas City, Kansas, which we had previously owned and which we sold to Sergeant’s Pet Care Products, Inc. (“Sergeant’s”) on August 21, 2009. Additionally, in November 2009, we entered into a joint venture with SEACOR Energy, Inc.’s affiliate, Illinois Corn Processing Holdings LLC (“ICP Holdings”), to reactivate distillery operations at our facility in Pekin, Illinois.  This facility is now owned and operated by a 50% owned, unconsolidated joint venture entity called Illinois Corn Processing, LLC (“ICP”), which reactivated the plant in the third quarter of fiscal 2010 after we temporarily closed it in the third quarter of fiscal 2009.   ICP produces food grade alcohol for beverage and industrial applications, which we purchase, and fuel grade alcohol, which SEACOR Energy, Inc. purchases.

 

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FISCAL 2010 DEVELOPMENTS

 

In fiscal 2010, we completed our transformation that began in fiscal 2009, when we determined to substantially exit the commodity and vital wheat gluten area of our business and curtail production of fuel grade alcohol and commodity wheat starch.  This transformation included the following steps:

 

·                  We exited the pet products business with the sale on August 21, 2009 of our Kansas City, Kansas facility to Sergeant’s Pet Care Products, Inc.  The sale included all equipment used for the production and packaging of pet-related products, principally consisting of extruded plant-based resins and finished pet treats. However, we retained ownership of equipment at this facility that is used for the production of our textured wheat proteins. This equipment is located in a separate section of the facility that we have leased for a period of three years ending August 20, 2012 and is operated by a subsidiary of Sergeants’ under a toll manufacturing arrangement.

 

·                  On November 20, 2009 we completed a series of transactions whereby we contributed our Pekin plant to a newly-formed company, ICP, and then sold 50% of the membership interest in this company to ICP Holdings, an affiliate of SEACOR Energy, Inc., for $15,000 cash ($13,951 net of closing costs).  ICP reactivated distillery operations at the Pekin facility during the third quarter ended March 31, 2010. We purchase food grade alcohol products manufactured by ICP, and SEACOR Energy, Inc. purchases fuel grade alcohol products manufactured by it.  By entering the joint venture arrangement, we recovered a portion of our investment in the Pekin plant and enhanced our ability to supply our food grade alcohol customers with quality product. Although we retain some exposure to the volatility of the fuel grade alcohol market through our investment in ICP, we have an opportunity to participate when the economics of that market are good, and we believe that the extent of our exposure to bad markets is significantly less than when we operated Pekin ourselves.  Further, we have the ability, through the termination provisions in the limited liability company agreement, to limit our operating losses by causing ICP to shut down the plant if losses reach specified amounts.  See “- Joint Ventures.”

 

·                  During fiscal 2010, we sold certain assets of our flour mill facility in Atchison for $671.  We also sold certain assets related to our wheat gluten and wheat starch processing facility in Pekin, Illinois for approximately $1,000.

 

We are concentrating our efforts on the development, production and commercialization of value-added ingredient solutions, consisting of specialty, value-added wheat proteins and wheat starches, and high quality beverage and food grade industrial alcohol.  The steps that we have taken to focus our business on the production of value-added products have improved our operating performance.  As a result of the measures we have taken, combined with lower raw material and natural gas costs, operating costs have been reduced, and cash flows from operating activities have increased from $3,158 in fiscal 2009 to $32,667 in fiscal 2010.  As a result of the improvement in our operating cash flow, combined with proceeds from the sale of our Kansas City facility and a 50% interest in ICP, tax refunds that we received in fiscal 2010 and proceeds from sales of assets from our closed Atchison flour mill and former Pekin protein and starch facility, we have been able to reduce our outstanding indebtedness from $30,612 on July 1, 2009 to $2,771 on June 30, 2010.

 

In June 2010 our Board approved a capital project designed to provide environmental benefits at our Atchison, Kansas distillery operations.  This project consists of the installation of a new, state-of-the-art process water cooling system to replace older equipment used to supply water for multiple components of the distillation process.  The project began in the summer of fiscal 2010 and is expected to be completed by the end of September 2011.   We originally estimated that this project would cost $7,400, but currently estimate the total cost at $8,500.

 

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FINANCIAL INFORMATION ABOUT SEGMENTS

 

Note 12 of our Notes to Consolidated Financial Statements set forth in Item 8 of this Report, which is incorporated herein by reference, includes information about sales, depreciation, income before income taxes and identifiable assets for the last two fiscal years by reportable segment.  Information about sales to external customers and assets located in foreign countries is included.

 

BUSINESS STRATEGY

 

We seek to strengthen our profit margins and improve returns on capital over time.  To enhance opportunities to achieve our objectives, we have streamlined our business and have modified our product portfolio to emphasize a greater mix of higher margin, value-added products, principally specialty food ingredients and high quality food grade alcohol.  To this end, we have taken measures to significantly reduce our production and marketing of lower and negative margin commodity type products.  Our strategy is focused on the development and marketing of wheat-based specialty protein and starch products and high quality food grade alcohol, as well as plant-based biopolymer and resin products for use in unique market niches.  We seek to add value to our customers’ major branded packaged goods products by providing product solutions across a range of food and beverage applications, as well as certain non-food product applications, that can ultimately benefit the consumer.

 

Market trends that we hope to benefit from include health and wellness lifestyle trends in the food area and growing demand for natural versus synthetic products.  Increased interest in bio-economy initiatives also may create opportunities for us, particularly in regard to our partially and totally degradable biopolymers.

 

As a component of our strategy, we have prioritized strengthening our overall operational capabilities and effectiveness through ongoing continuous improvement projects.  Simultaneously, we are boosting our efforts to place greater focus on research, development and innovation initiatives, sales and marketing activities, supply chain and business management and analytical processes, best in class customer service practices, and measures to realize greater savings and/or return on selling, general administrative and manufacturing expenses.   We continue to concentrate on specific, highly functional ingredient solutions for our customers.  We are concentrating our production and marketing efforts on supplying a core base of loyal customers with an array of high quality, premium ingredients that address nutritional, sensory and convenience issues and that can help build value while making more efficient use of our existing capacities.  We continue to step up our product innovation and commercialization efforts.

 

We continue to be a leading company in the food grade alcohol industry and pursue efforts to maintain highly efficient alcohol production operations.  Since early 2004, the majority of our Atchison distillery’s capacity has been dedicated to the production of high quality, high purity food grade alcohol for beverage and industrial applications.  It presently only produces a minimal amount of fuel alcohol as a co-product of our food grade production activities.  The majority of our former Pekin plant’s capacity for several years had been dedicated to the production of fuel grade alcohol.   The Pekin plant is now owned and operated by a joint venture, ICP, which produces food grade alcohol for beverage and industrial applications, which we purchase, and fuel grade alcohol, which SEACOR Energy, Inc. purchases, as elsewhere described.

 

We continued to experience generally favorable conditions in the food grade alcohol market in fiscal 2010, providing our customers with what we believe is among the highest quality, high purity alcohol in the world.  We have been in the food grade alcohol business since the Company’s founding in 1941.

 

As stated previously, biopolymers continue to represent an emerging part of our business.  Currently, we have two commercial products in the market. The first product comprises plant-based

 

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biopolymers in which a large percentage of petroleum-based plastic could be replaced with materials made from renewable sources, specifically wheat starch.  These biopolymers, which serve as bio-based alternatives to traditional plastics, may be utilized in a wide range of products, such as disposable cutlery, cosmetic cases and toy products.  The second product is a wood-based composite resin, which compounds wood and recycled plastic materials.  This product is used in the manufacture of deck boarding and other wood applications in which long-term durability is required.  These products are sold directly to producers of finished products. We are also continuing work on the development and commercialization of a fully bio-based, fully compostable resin.

 

PRODUCT SALES

 

The following table shows our sales from continuing operations by each class of similar products during the past two fiscal years ended June 30, 2010 and June 30, 2009, as well as such sales as a percent of total sales.

 

 

 

PRODUCT GROUP SALES
Fiscal Year Ended,

 

 

 

June 30, 2010

 

June 30, 2009 (1)

 

 

 

Amount

 

%

 

Amount

 

%

 

Ingredient Solutions: (2)

 

 

 

 

 

 

 

 

 

Specialty Proteins

 

$

20,847

 

10.3

%

$

21,936

 

7.5

%

Specialty Starches

 

27,978

 

13.9

%

32,817

 

11.2

%

Vital Wheat Gluten

 

1,825

 

0.9

%

13,684

 

4.8

%

Commodity Wheat Starch

 

9,065

 

4.5

%

12,629

 

4.3

%

Mill By-Products

 

 

0.0

%

1,061

 

0.4

%

Total Ingredients

 

$

59,715

 

29.6

%

$

82,127

 

28.2

%

 

 

 

 

 

 

 

 

 

 

Distillery Products: (3)

 

 

 

 

 

 

 

 

 

Food grade Alcohol

 

$

118,578

 

58.7

%

$

124,199

 

42.6

%

Fuel grade Alcohol

 

7,072

 

3.5

%

47,445

 

16.2

%

Distillers Grain and other Co-products

 

14,340

 

7.1

%

33,060

 

11.3

%

Total Distillery Products

 

$

139,990

 

69.3

%

$

204,704

 

70.1

%

 

 

 

 

 

 

 

 

 

 

Other Products: (4)

 

$

2,266

 

1.1

%

$

4,981

 

1.7

%

Net Sales

 

$

201,971

 

100.0

%

$

291,812

 

100.0

%

 


(1)                                  Fiscal 2009 sales have been corrected to include customer paid freight costs billed to customers.  For further discussion, see Note 1 Nature of Operations and Summary of Significant Accounting Policies in Item 8.

(2)                                  In October 2008, we shut down our Atchison wheat flour mill and began purchasing high quality flour for use as the principal raw material in our protein and starch production processes.  As a result, we quit selling Mill By-Products.  In November 2008, we discontinued producing protein and starch at our Pekin facility and consolidated production of value-added protein and starch products at our Atchison facility. These actions were driven by our planned reduction in the manufacturing and sales of commodity vital wheat gluten and significantly curtailed emphasis on the production and commercialization of commodity wheat starch.

(3)                                  In February 2009, we temporarily discontinued distillery operations at our Pekin facility. We now only produce minimal quantities of fuel grade alcohol as a co-product of our food grade alcohol production at our Atchison facility.  As a result, our production of distillers feed, a principal co-product of our alcohol production process, also has declined.  The table includes our sales of food grade alcohol acquired from ICP but does not otherwise reflect distillery product sales of ICP, which now operates our former Pekin plant.

(4)                                  Other products formerly included personal care products and pet products. We ceased production of personal care products in the third quarter of fiscal 2009 and sold our pet business in the first quarter of fiscal 2010.

 

Substantially all of our sales are made directly or through distributors to manufacturers and processors of finished packaged goods.  Sales to our customers purchasing food grade alcohol are made primarily on a spot, monthly, or quarterly basis with some annual contracts, depending on the customer’s needs and market conditions.  Sales of fuel grade alcohol are made on the spot market.  Contracts with distributors may be for multi-year terms with periodic review of pricing.  Contracts with ingredients customers are generally price and term agreements which are fixed for quarterly or six month periods, with very few agreements of twelve months duration or more.  During fiscal 2010, our five largest distillery products customers accounted for 24.2% of our consolidated revenues. Our five largest ingredients products customers combined accounted for 18.0% of our consolidated revenues in fiscal 2010.

 

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INGREDIENT SOLUTIONS SEGMENT

 

Our ingredient solutions segment consists primarily of specialty wheat starches, specialty wheat proteins, commodity wheat starch and vital wheat gluten.  Through the second quarter of fiscal 2009, mill feeds, the principal by-product of the flour milling process, was also included in this segment.  With the discontinuation of our wheat milling operations, we have ceased the production and sales of mill feeds. As noted above, we have substantially exited the commodity wheat gluten market and have curtailed the production of commodity wheat starches.

 

In recent years, our specialty wheat starches and proteins have accounted for a sizeable share of our total sales in this segment.  This primarily has been due to the following factors: product mix optimization, product innovation through increased research and development, partnering with customers on product development, increased capacity to produce these products and increased marketing efforts that have resulted in greater customer recognition.

 

Specialty Wheat Starches.  Wheat starch constitutes the carbohydrate-bearing portion of wheat flour.  We produce a pure white premium wheat starch powder by extracting the starch from the starch slurry, substantially free of all impurities and fibers, and then by spray, flash or drum drying the starch.  Premium wheat starch differs from low grade or B wheat starches, which are extracted along with impurities and fibers and are used primarily as a binding agent for industrial applications, such as the manufacture of charcoal briquettes.  We do not produce low grade or B starches because our integrated processing facilities are able to process the slurry remaining after the extraction of premium wheat starch into alcohol and animal feed.  Premium wheat starch differs from corn starch in its granular structure, color, granular size and name identification.

 

A substantial portion of our premium wheat starch is altered during processing to produce certain unique specialty wheat starches designed for special applications.  Our strategy is to market our specialty wheat starches in special market niches where the unique characteristics of these starches are better suited to a customer’s requirements for a specific use.  We have developed a number of different specialty wheat starches, and continue to explore the development of additional starch products with the view to increasing sales of value-added specialty starches.  We produce our Fibersym® resistant starch, which has become one of our more popular specialty starches, using a patented technology referred to below under Patents.  We sell our specialty starches on a nationwide basis, primarily to food processors and distributors.

 

Our specialty wheat starches are used primarily for food applications as an additive in a variety of food products to affect their nutritional profile, appearance, texture, tenderness, taste, palatability, cooking temperature, stability, viscosity, binding and freeze-thaw characteristics.  Important physical properties contributed by wheat starch include whiteness, clean flavor, viscosity and texture.  For example, our starches are used to improve the taste and mouth feel of cream puffs, éclairs, puddings, pie fillings, breadings and batters; to improve the size, symmetry and taste of angel food cakes; to alter the viscosity of soups, sauces and gravies; to improve the freeze-thaw stability and shelf life of fruit pies and other frozen foods; to improve moisture retention in microwavable foods; and to add stability and to improve spreadability in frostings, mixes, glazes and sugar coatings.  We also sell our specialty starches for a number of non-food applications, which include biopolymer products, and for use in the manufacture of adhesives, paper coatings, carbonless paper, and wall board.

 

Our wheat starches as a whole generally compete primarily with corn starch, which dominates the United States starch market.  However, the unique characteristics of our specialty wheat starches provide them with a number of advantages over corn and other starches for certain baking and other end uses.  Our principal competitors in the starch market are Cargill Incorporated (primarily corn and tapioca starch), National Starch and Chemical Corporation (corn starch), Manildra Milling Corporation (wheat starch), Penford Corporation (potato starch), Archer-Daniels-Midland Company (wheat and other grain starches) and various European companies.  Competition is based upon price, name, color and differing granular

 

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characteristics which affect the food product in which the starch is used.  Specialty wheat starches usually enjoy a price premium over corn starches and low grade wheat starches. Commodity wheat starch price fluctuations generally track the fluctuations in the corn starch market.  As we experienced in fiscal 2010, the specialty wheat starch market usually permits pricing consistent with costs which affect the industry in general, including increased grain costs.  However, this is not always the case; during fiscal 2006 and fiscal 2003, for example, increases in grain and fuel prices outpaced market price increases in the specialty wheat starch market.

 

Specialty Wheat Starches

 

·                                          Fibersym® Resistant Starch series.  These starches serve as a convenient and rich source of dietary fiber.  Unlike traditional fiber sources like bran, our resistant starches possess a clean, white color and neutral flavor that allow food formulators to create a wide range of both traditional and non-traditional fiber enhanced products that are savory in both appearance and taste.  Applications include pan breads, pizza crust, flour tortillas, cookies, muffins, pastries and cakes.

 

·                                          FiberRite® RW Resistant Starch.  FiberRite® RW is a product that boosts dietary fiber levels while also reducing fat and caloric content in such foods as breads, sweet goods, ice cream, yogurt, salad dressings, sandwich spreads and emulsified meats.

 

·                                          Pregel Instant Starch series.  Our Pregel starches perform as an instant thickener in bakery mixes, allowing fruit, nuts and other particles such as chocolate pieces to be uniformly suspended in the finished product.  In coating systems, batter pick-up can be controlled for improved yield and consistent product appearance.  Additionally, shelf-life can be enhanced due to improved moisture retention, allowing products to remain tender and soft over an extended storage period.

 

·                                          Midsol Cook-up Starch series.  These starches deliver increased thickening, clarity, adhesion and tolerance to high shear, temperature and acidity during food processing.  Such properties are important in products such as soups, sauces, gravies, salad dressings, fillings and batter systems.  Processing benefits of these starches also include the ability to control expansion in extruded breakfast cereals.  In addition, they provide textural enhancement and moisture management in processed foods, especially during storage under frozen and refrigerated conditions.

 

Commodity Wheat Starch.  As is the case with value-added wheat starches, our commodity wheat starch has both food and non-food applications, but such applications are more limited than those of value-added wheat starches and typically sell for a lower price in the marketplace.  As noted above, commodity wheat starch competes primarily with corn starches, which dominate the marketplace and prices generally track the fluctuations in the corn starch market.

 

Specialty Wheat Proteins.  We have developed a number of specialty wheat proteins for food and non-food applications. Specialty wheat proteins are derived from vital wheat gluten through a variety of proprietary processes which change its molecular structure.  Wheat proteins for food applications include products in the Arise®, Wheatex®, HWG 2009™ and FP™ series.  Our specialty wheat proteins generally compete with other ingredients and modified proteins having similar characteristics, primarily soy proteins and other wheat proteins, with competition being based on factors such as functionality, price and, in the case of food applications, flavor. Our principal competitors in the specialty proteins market are Archer-Daniels-Midland Company (wheat and other grain proteins), The Solae Company (soy), Manildra Milling (gluten and wheat proteins), and various European companies.  Although we are producing a number of our specialty wheat proteins on a commercial basis, some products are in the test marketing or development stage.

 

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Specialty Wheat Proteins

 

·                                          Arise® series.  Our Arise® series of products consists of specialty wheat proteins that increase the freshness and shelf life of frozen, refrigerated and fresh dough products after they are baked. Certain ingredients in this series are also sold for use in the manufacture of high protein, lower net carbohydrate products.

 

·                                          Wheatex® series.  This series consists of texturized wheat proteins made from vital wheat gluten by changing it into a pliable substance through special processing.  The resulting solid food product can be further enhanced with flavoring and coloring and reconstituted with water.  Texturized wheat proteins are used for meat, poultry and fish substitutes, extenders and binders.  Wheatex® mimics the textural characteristics and appearance of meat, fish and poultry products.  It is available in a variety of sizes and colors and can be easily formed into patties, links or virtually any other shape the customer requires.

 

·                                          FP series.  The FP™ series of products consists of specialty wheat proteins, each tailored for use in a variety of food applications. These include proteins that can be used to form barriers to fat and moisture penetration to enhance the crispness and improve batter adhesion in fried products, effectively bond other ingredients in vegetarian patties and extended meat products, increase the softness and pliability of flour tortillas, and fortify nutritional drinks.

 

·                                          HWG 2009.  This is a lightly hydrolyzed wheat protein that is rich in peptide-bonded glutamine, an amino acid that counters muscle fatigue brought on by exercise and other physical activities. Applications include nutritional beverages and snack products.

 

Vital Wheat Gluten.   Vital wheat gluten is a free-flowing light tan powder which contains approximately 75 to 80 percent protein.  When we process flour to derive starch, we also derive vital wheat gluten.  Vital wheat gluten is added by bakeries and food processors to baked goods, such as breads, and to pet foods, cereals, processed meats, fish and poultry to improve the nutritional content, texture, strength, shape and volume of the product.  The neutral flavor and color of wheat gluten also enhances, but does not change, the flavor and color of food.  The cohesiveness and elasticity of the gluten enables the dough in wheat and other high protein breads to rise and to support added ingredients, such as whole cracked grains, raisins and fibers.  This allows the baker to make an array of different breads by varying the gluten content of the dough.  Vital wheat gluten is also added to white breads, hot dog buns and hamburger buns to improve the strength and cohesiveness of the product.

 

Vital wheat gluten in recent years has been considered a commodity, and therefore, competition primarily has been based upon price.

 

In prior years, vital wheat gluten has sometimes been a principal ingredients product.  However, we generally have been unable to compete with subsidized imports and now try to limit our production to quantities needed for further processing of our specialty wheat proteins.

 

DISTILLERY PRODUCTS SEGMENT

 

Our Atchison plant processes corn, mixed with the starch slurry from wheat starch and protein processing operations, into food grade alcohol and distillery co-products consisting of fuel grade alcohol and distillers feed.

 

Food grade alcohol consists of beverage alcohol and industrial food grade alcohol that are distilled to remove impurities.  Fuel grade alcohol, is grain alcohol that has been distilled to remove all water to yield 200 proof alcohol suitable for blending with gasoline.  In fiscal 2009, we decided to reduce our exposure to the fuel grade alcohol market and presently generate and sell only minimal amounts as a co-product of the food grade alcohol production process at our Atchison distillery.

 

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In February 2009, we temporarily discontinued operations at our former Pekin facility.  Historically, the Pekin plant had been principally dedicated to the production of fuel grade alcohol; although shortly before the shutdown we had reduced fuel grade production and were making increased quantities of food grade alcohol at the plant.  On November 20, 2009, we completed a series of transactions whereby we contributed our former Pekin plant to a newly-formed company, ICP, and then sold 50% of the membership interest this company to ICP Holdings, an affiliate of SEACOR Energy Inc., for $15,000 cash ($13,951 net of closing costs). ICP reactivated distillery operations at the Pekin facility during the third quarter ended March 31, 2010. We purchase food grade alcohol products manufactured by ICP and SEACOR Energy Inc. purchases fuel grade alcohol products manufactured by it.

 

Food Grade Alcohol.  Since the reconstruction in 2004 of our Atchison distillery following an explosion that occurred approximately two years earlier, the majority of the distillery’s capacity has been dedicated to the production of high quality, high purity food grade alcohol for beverage and industrial applications.    The new state-of-the-art equipment that was installed during the reconstruction has resulted in improved alcohol production efficiencies at the Atchison plant.  During fiscal 2010, we generally operated at full production capacity for our food grade alcohol at the Atchison plant.

 

Food grade alcohol sold for beverage applications consists primarily of grain neutral spirits and gin.  Grain neutral spirits are sold in bulk quantities at various proof concentrations to bottlers and rectifiers, which further process the alcohol for sale to consumers under numerous labels.  Our gin is created by redistilling grain neutral spirits together with proprietary customer formulations of botanicals or botanical oils.

 

We believe that in terms of fiscal 2010 net sales, we are one of the three largest bulk sellers of food grade alcohol in the United States.  Our principal competitors in the beverage alcohol market are Grain Processing Corporation of Muscatine, Iowa and Archer-Daniels-Midland Company of Decatur, Illinois.

 

Much consolidation in the beverage alcohol industry has occurred at the customer level over the past two decades.  As these consolidations have come about, we have maintained a strong and steady presence in the market due to longstanding relationships with customers and our reputation for producing very high quality, high purity alcohol products.

 

We market food grade alcohol which is not sold as beverage alcohol as food-grade industrial alcohol.  We sell food-grade industrial alcohol for use as an ingredient in foods (e.g., vinegar and food flavorings), personal care products (e.g., hair sprays and deodorants), cleaning solutions, biocides, insecticides, fungicides, pharmaceuticals, and a variety of other products.  Although grain alcohol is chemically the same as petroleum-based or synthetic alcohol, certain customers prefer a natural grain-based alcohol.  We sell food-grade industrial alcohol in tank truck or rail car quantities direct to a number of industrial processors.

 

Historically, synthetic alcohol was a highly significant component of the food grade industrial alcohol market.  In recent years, however, the use of grain-based alcohol has exceeded synthetic alcohol in this market.  Our principal competitors in the grain-based food grade industrial alcohol market are Grain Processing Corporation of Muscatine, Iowa and Archer-Daniels-Midland Company of Decatur, Illinois.  Competition is based primarily upon price, service and quality factors.

 

Distillery Co-Products.

 

Fuel Grade Alcohol.  The bulk of fiscal 2010 sales of alcohol co-products consisted of fuel grade alcohol and distillers feed. Fuel grade alcohol is sold primarily for blending with gasoline to increase the octane and oxygen levels of the gasoline.  As an octane enhancer, fuel grade alcohol can serve as a substitute for lead and petroleum-based octane enhancers.  As an oxygenate, fuel grade alcohol has been used in gasoline to meet certain environmental regulations and laws relating to air quality by reducing carbon monoxide, hydrocarbon particulates and other toxic emissions generated from the burning of

 

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gasoline (“toxics”).  Because fuel grade alcohol is produced from grain, a renewable resource, it also provides a fuel alternative that tends to reduce the country’s dependence on foreign oil.

 

To encourage the production of fuel grade alcohol for use in gasoline, the Federal government and various states have enacted tax and other incentives designed to make fuel grade alcohol competitive with gasoline and gasoline additives.  Under the internal revenue code, and until the end of the 2010 calendar year, gasoline that has been blended with fuel grade alcohol provides sellers of the blend with certain credits or payments.  Until the end of 2008, these amounted to $0.51 per gallon of fuel grade alcohol with a proof of 190 or greater that is mixed with the gasoline; during 2009 and 2010, they amounted to $0.45 per gallon.  Although these benefits are not directly available to us, they were intended to permit us to sell our fuel grade alcohol at prices which generally are competitive with less expensive additives and gasoline.  Various initiatives have been proposed to extend the credit.  However, the outcome and/or extent of such proposals is uncertain.

 

At times in the past, there has been significant volatility in corn and fuel grade alcohol markets, making incremental fuel grade alcohol production decisions difficult.  In fiscal 2009, we were experiencing fuel grade alcohol prices below our production costs.  With industry capacity in excess of federal mandates, it did not seem likely to us that equilibrium would return to the fuel grade alcohol markets in the short term.  Accordingly, we determined to substantially reduce our production of this product and now only produce fuel grade alcohol as a co-product of our food grade alcohol business at our distillery in Atchison.  Although we retain some exposure to the volatility of the fuel alcohol market through our investment in ICP, we have an opportunity to participate when the economics of that market are good and we believe that the extent of our exposure to bad markets is significantly less than when we operated Pekin ourselves.

 

Major market participants in the fuel grade alcohol market include Poet Biorefining, Archer-Daniels-Midland Company and Valero Energy Corporation, which together account for approximately 31% of the total production capacity.  We and our joint venture, ICP, compete with other producers of fuel grade alcohol on the basis of price and delivery service.

 

Distillers Feed.  Distillers feed is principally derived from the residue of corn from alcohol processing operations.  The residue is dried and sold primarily to processors of animal feeds as a high protein additive.  We compete with other distillers of alcohol as well as a number of other producers of animal food additives in the sale of distillers feed.  In fiscal 2010, distillers feed prices were lower on average compared to the prior year due to reduced prices for corn, the basic raw material from which distillers feed is derived.   During fiscal 2009, prices for distillers feed were depressed relative to corn prices as a result of increased fuel alcohol capacity combined with decreased demand in the European Union due to the E.U.’s non-approval of several varieties of genetically modified corn commonly grown in the U.S.

 

OTHER SEGMENT

 

Our plant-based biopolymers and composite resins, which are produced from the further processing of certain of our wheat proteins and wheat starches (and other plant sources), can be used to produce a variety of eco-friendly products. We formerly manufactured plant-based resins for use primarily in pet treat applications.  Our production of the pet-related products was discontinued with the sale of our pet products business and Kansas City facility in August 2009. After giving effect to the sale, our principal products in our other segment consist of our MGPI Terratek® biopolymers and composite resins.   The MGPI Terratek® SC starch-based biopolymers are our environmentally-friendly biopolymers that can be molded to produce a variety of formed objects. Applications include disposable eating utensils, golf tees, food and feed containers and similar type vessels, as well as non-degradable hard plastic-like products.   We hold a license under U.S. Patent No. 5,321,064 expiring in 2011 that relates to these products.  We also produce MGPI Terratek® WC wood-based composite resins, which can be used in the manufacture of eco-friendly decking materials, furniture parts, toys and a number of other wood-like products.

 

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PATENTS

 

We are involved in a number of patent-related activities.  We have filed patent applications to protect a range of inventions made in our expanding research and development efforts, including inventions relating to applications for our products.  Our most significant patents or patent licenses are described below.

 

In 2003, we licensed, on an exclusive basis, certain patented technology from The Kansas State University Research Foundation relating to U. S. Patent No. 5,855,946, which describes and claims processes for making food-grade starches resistant to alpha-amylase digestion, as well as products and uses for the resistant starches.  The license relates to products derived from plant-based starches and is a royalty-bearing, worldwide license whose term, subject to termination for material, uncured breaches or bankruptcy, extends until the patent rights expire in 2017.  Royalties generally are based on net sales.  The patent rights relate to the referenced U.S. patent and any corresponding foreign patent application, which has been filed in Australia.  Under the license, we can make, have made, use, import, offer for sale, and sell licensed products within the scope of a claim of the patent rights or which are sold for a use within the scope of the patent rights and may, with approval of the licensor, grant similar rights to sublicensees.  We produce and sell our resistant wheat starch under this patent.  We have granted National Starch and Chemical Investment Holding Corporation and certain of its affiliates a royalty bearing sublicense under the patent and related technology to make high amylose maize starch and to sell it anywhere except in the United States.  We have granted Cargill Incorporated a royalty bearing sublicense to use the patented process in the production of tapioca-based starches for use in food products.  We also have agreements with Cargill that would apply if we determined to use the patented process to make or have made starches derived from other plant sources (other than wheat or potato).

 

We hold U.S. Patent No. 5,610,277 expiring in 2015 relating to the alcohol-free wet extraction of gluten dough into gliadin and glutenin.

 

We are exclusively licensed by the University of Minnesota under U. S. Patent No. 5,321,064, which relates to biodegradable interpolymer compositions made from biodegradable natural and synthetic polymers.  The license expires on June 14, 2011, as does the licensed patent.

 

RESEARCH AND DEVELOPMENT

 

During the last three fiscal years, we have spent an aggregate of $5,500 on research and development activities, principally all in the ingredient solutions and other segments, as follows: 2010-$900; 2009-$1,400; and 2008-$3,200.

 

SEASONALITY

 

Our sales subsequent to 2002 have not been seasonal.

 

TRANSPORTATION

 

Our output is transported to customers by truck and rail transportation equipment, most of which is provided by common carriers.  We currently lease 343 rail cars, which may be dispatched on short notice.  ICP, our joint venture operation in Pekin, Illinois also has the ability to transport by barge from its site, with barge loading facilities on the Illinois River.

 

RAW MATERIALS

 

Our principal raw material is wheat flour, which is processed into our starches and proteins, and corn, which is processed into food grade alcohol, and distillery co-products consisting of fuel grade alcohol, and animal feed.  We purchase corn throughout the year from or through grain elevators. 

 

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Currently we purchase our corn requirements from a single elevator company. Our practice is to order corn for a month at a time.  We provide for our flour requirements through a supply contract with ConAgra Mills whose initial term, as amended, expires in October 2015.  The supply contract is automatically renewable for an additional term of 5 years unless either party gives at least 180 days written notice of termination. Pricing is based on a formula that contains several factors, including wheat futures prices, mill feed prices and freight costs.

 

Historically, the cost of grain has been subject to substantial fluctuations depending upon factors such as crop conditions, weather, government programs and purchases by foreign governments.  Variations in grain prices have had from time to time significant adverse effects on the results of our operations in cases where we cannot recoup the cost increase in our selling prices.  Fuel grade alcohol prices, which historically have tracked the cost of gasoline, do not usually adjust to rising grain costs.  It generally has been difficult for us to compensate for increases in grain costs through adjustments in prices charged for our vital wheat gluten due to subsidized European Union wheat gluten, whose traditionally lower prices are not affected by such costs.   We have taken steps to reduce the impact of cost fluctuations on our business,  primarily by ceasing and/or significantly reducing our production and marketing of lower and negative margin commodity type products such as gluten and fuel grade alcohol, but we may continue to be affected by  cost fluctuations to some degree.

 

Historically, we have engaged in the forward purchase of grain and in the purchase of commodity futures and options to hedge economic risks associated with fluctuating grain and grain products prices.   Under our current hedging program, we generally purchase commodity futures and options and contract for the future delivery of grain only to protect margins on contracted alcohol sales.  We intend to contract for the future delivery of flour only to protect margins on expected sales of ingredients products.  See Item 1A — Risk Factors and Item 7 — Management’s Discussion and Analysis of Financial Condition and Results of Operations — Critical Accounting Practices — Hedging Activities.  Also see Item 7A - Quantitative and Qualitative Disclosures About Market Risk.

 

ENERGY

 

Because energy comprises a major cost of operations, we seek to assure the availability of fuels at competitive prices.

 

We use natural gas to operate boilers that we use to make steam heat.  We procure natural gas for the Atchison plant in the open market from various suppliers.  We can purchase contracts for the delivery of natural gas in the future or can purchase future contracts on the exchange.  Depending on existing market conditions, at Atchison we have the ability to transport the gas through a gas pipeline owned by a wholly-owned subsidiary.  Historically, prices of natural gas have been higher in the late fall and winter months than during other periods.

 

We have a risk management program whereby, at pre-determined prices, we may purchase a portion of our natural gas requirements for future delivery.  However, we intend to enter contracts for future delivery only to protect margins on contracted alcohol sales and expected ingredients sales.

 

EMPLOYEES

 

As of June 30, 2010, we had a total of 193 employees of which 99 were covered by a collective bargaining agreement with one labor union.  This agreement, which expires on August 31, 2014, covers employees at the Atchison Plant.  As of June 30, 2009, we had 322 employees.

 

Although we experienced a brief work stoppage at the Atchison plant from September 27 through October 10 in 2008, we consider our relations with our personnel to generally be good.   Previously, we had not experienced a work stoppage since 1978.

 

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REGULATION

 

Our beverage and industrial alcohol business is subject to regulation by the Alcohol and Tobacco Tax and Trade Bureau (“TTB”) and the alcoholic beverage agencies in the States of Kansas and Illinois.  Such regulation covers virtually every aspect of our alcohol operations, including production facilities, marketing, pricing, labeling, packaging, and advertising.  Food products are also subject to regulation by the Food and Drug Administration.  TTB regulation includes periodic TTB audits of all production reports, shipping documents, and licenses to assure that proper records are maintained.  We are also required to file and maintain monthly reports with the TTB of alcohol inventories and shipments.

 

We are subject to extensive environmental regulations at the federal, state and local levels.  The regulations include the regulation of water usage, waste water discharge, disposal of hazardous wastes and emissions of volatile organic compounds, nitrogen oxides, sulfur dioxides, particulates and other substances into the air.  Under these regulations, we are required to obtain operating permits and to submit periodic reports to regulating agencies.  For the Atchison, Kansas plant, the air quality is regulated by both the U.S. Environmental Protection Agency (“USEPA”) and the Division of Environment of the Kansas Department of Health and Environment (the “KDHE”).  The KDHE regulates all air emissions.  We also were required to obtain a Class I air operating permit from the KDHE and must obtain KDHE approval to make plant alterations that could modify the emission levels.  The KDHE also regulates the discharge water quality at the Atchison plant.  This includes process water, non-contact water and storm water.  We monitor process water and non-contact water discharge on a daily basis and submit monthly reports to the KDHE documenting the test results from these water discharges.  The USEPA and KDHE also monitor hazardous waste disposal for the Atchison plant.  We also are required to submit annual reports pursuant to the Kansas and Federal Emergency Planning Community Right-to-Know Acts.  Local officials, such as the local emergency planning committee in the Atchison community, also receive copies of these annual reports.  We additionally file an Annual Emissions Report and a Toxic Release Inventory annually with the KDHE.  The Atchison facility is also required to submit periodic reports pursuant to the Federal Emergency Planning Community Right-to-Know Acts. We are working with the KDHE to renew our National Pollutant Discharge Elimination System (“NPDES”) permit for an extended period of up to five years.  This renewal permit requires the installation of our new distillery cooling water system referred to below at the Atchison plant.  This system will involve the installation of a new, state-of-the art process water cooling system to replace older equipment used to supply water for multiple components of the distillation process at our Atchison plant at an estimated cost of $8,500.  The new system is designed to meet KDHE Volatile Organic Compounds (“VOC”) emission standards, while also enhancing alcohol production efficiencies.

 

Similar environmental regulations apply to the operations of ICP, our joint venture in Pekin, Illinois.  Air quality at the Pekin plant is regulated by both the USEPA and the Illinois Environmental Protection Agency (the “IEPA”).  The IEPA regulates all air emissions.  The joint venture has permits to make certain emissions, and the IEPA has the right to do on-site testing to verify that emissions comply with these permits.  Also, the IEPA regulates waste water, cooling water and storm water discharge at the Pekin plant. The joint venture tests wastewater effluent quality twice each week and files monthly reports with the IEPA.  It also files an Annual Emissions Report and a Toxic Release Inventory annually with the IEPA.  Likewise, the Pekin facility is also required to submit periodic reports pursuant to the Federal Emergency Planning Community Right-to-Know Acts.

 

In January 2006 we entered a consent agreement with the KDHE resolving past allegations relating to permits, emissions levels and compliance with pollution regulations.  We agreed to pay a civil penalty and to undertake certain modifications to our Atchison facility over two and one-half years, including replacing a dryer, replacing or modifying our boilers and modifying certain emission controls.  We had previously installed the emission-controlled dryer in Atchison that we will use to process distillers feed at an estimated cost of $12,000.  During fiscal 2008 we made additional capital expenditures of $1,823 for new boiler burners and emission controls at the Atchison plant and made an additional $415 in expenditures during fiscal 2009 for such measures at this facility.

 

From September 16, 2008 until February 11, 2009, tests on our feed drying unit in Atchison indicated that it was not in compliance with the volatile organic compound emission limit established in the

 

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consent agreement entered in 2006.  Official compliance testing in February 2009 demonstrated the unit to be in compliance.  In November 2009, we entered an amendment to the consent agreement wherein the KDHE addressed our non-compliance with the emission limit and related testing, monitoring and permitting violations and assessed a civil penalty of $66.

 

During the second half of fiscal 2010, due to increased production activity we anticipated that we would exceed the emissions cap imposed by the KDHE in the 2006 consent and began negotiating a second amendment to the consent agreement with the KDHE.  The second amendment, which was approved by the KDHE in May 2010, requires us to complete the closed-loop, process cooling water system project described above, resulting in significant VOC reduction, in accordance with a scheduled timeline extending over an approximate seventeen month period which ends on September 30, 2011.  We have agreed to pay a $5 per month penalty for any month that we exceed the rolling 12-month emissions cap imposed in the consent agreement, as well as a $1 per day penalty for each day we fail to file monthly progress reports or exceed established completion dates for various stages of the project. The most recent results, compiled on August 25, 2010 show that we have not exceeded the emissions cap and therefore we have not been subject to related penalties.

 

JOINT VENTURES

 

Illinois Corn Processing, LLC. On November 20, 2009 we completed a series of related transactions pursuant to which we contributed our Pekin plant and certain maintenance and repair materials to a newly-formed company, Illinois Corn Processing, LLC (“ICP”), and then sold 50% of the membership interest in ICP to Illinois Corn Processing Holdings LLC (“ICP Holdings”), an affiliate of SEACOR Energy Inc., for proceeds of $15,000, less closing costs of $1,049.  ICP reactivated distillery operations at the Pekin facility during the third quarter of fiscal 2010. We purchase food grade alcohol products manufactured by ICP, and SEACOR Energy Inc. purchases fuel grade alochol products manufactured by ICP.

 

In connection with these transactions, we entered into various agreements with ICP and ICP Holdings, including a Contribution Agreement, an LLC Interest Purchase Agreement, a Limited Liability Company Agreement and a Marketing Agreement.

 

·                  Pursuant to the Contribution Agreement, we contributed the Pekin plant to ICP at an agreed value of $30,000, consisting of land and fixed assets valued at $29,063 and materials and supply inventory valued at $937.

 

·                  Under the LLC Interest Purchase Agreement, we sold ICP Holdings 50% of the membership interest in ICP for a purchase price of $15,000.  This agreement gives ICP Holdings the option to purchase up to an additional 20% of the membership interest in ICP at any time between the second and fifth anniversary of the closing date for a price equal to the percentage of such interests times the greater of (i) four times ICP’s trailing twelve months EBITDA or (ii) $40,000, adjusted for pro rata additional capital investment, as defined in the agreement (“Option Price”).

 

·                  Pursuant to the Limited Liability Company Agreement, each joint venture party initially has 50% of the voting and equity interests in ICP.  Control of day to day operations generally is retained by the members, acting by a majority in interest.  However, if either MGPI or SEACOR Energy is in default under its marketing agreement, referred to below, the other party (or ICP Holdings, in the case of a default by us) may assume sole control of ICP’s daily operations until the default is cured.  If ICP defaults for two consecutive months on its obligation to pay principal or interest on its loan from SEACOR Energy’s affiliate, ICP Holdings may assume control of ICP’s daily operations until it has positive EBITDA and is current on principal and interest payments.

 

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The Limited Liability Company Agreement also provides for the creation of an advisory board consisting of three advisors appointed by us and three advisors appointed by ICP Holdings. If ICP Holdings exercises its purchase option described above, it will be entitled to appoint four advisors and we will be entitled to appoint two.

 

The Limited Liability Company Agreement generally provides for distributions to members to the extent of net cash flow, as defined, to provide for taxes attributable to allocations to them of tax items from ICP.  Any distributions of net cash flow in excess of taxes may be distributed at such time as the Board of Advisors determines.

 

The Limited Liability Company Agreement gives either member certain rights to shut down the plant if it operates at a loss.  Such rights are conditional in certain instances but absolute if EBITDA losses aggregate $1,500 over any three consecutive quarters or if ICP’s net working capital is less than $2,500.  ICP Holdings also has the right to shut down the plant if ICP is in default under its loan agreement for failure to pay principal or interest for two months.

 

The Limited Liability Company Agreement contains various buy/sell provisions and restrictions on the transfer of membership interests. These include buy/sell provisions relating to a member’s entire interest that may apply if the members are unable to agree on a material decision about ICP or that may be exercised by any member at any time after November 20, 2010.  If ICP is the offeror, prior to November 20, 2011 its proposed purchase price per percentage interest cannot be less than the Option Price.  Another provision would entitle us to a disproportionate distribution of the excess of the sales price over specified amounts if ICP is sold before November 20, 2012.

 

·                  Under the Marketing Agreement, ICP manufactures and supplies food grade and industrial-use alcohol products for us and we purchase, market and sell such products for a marketing fee.  The Marketing Agreement provides that we will share margin realized from the sale of the products under the agreement with ICP.

 

The Marketing Agreement has an initial term of one year but automatically renews for one year terms thereafter, subject to specified exceptions, including the following:  (i) there is an uncured breach by one of the parties, (ii) we give timely notice of termination, (iii) we cease to be a member of the joint venture, or (iv) the parties are unable to mutually agree to modifications to the Marketing Agreement that are proposed in good faith by one of the parties as necessary or desirable to further the purposes of the parties’ respective expectations of economic benefits to be derived under the Marketing Agreement and their interests in ICP.  For six months following expiration or termination of the Marketing Agreement, ICP will provide us with reasonable assistance to transition production of the products it makes for us to another producer that we designate.   SEACOR Energy Inc. has entered into a similar agreement with ICP with respect to the marketing of fuel grade alcohol.

 

An affiliate of SEACOR Energy, Inc. has provided funding to ICP through two loans secured by all of the assets of ICP, including the Pekin Plant. Among other matters, losses or working capital deficiencies that would entitle a member of ICP to shut down the plant are events of default under these loan agreements which, upon any requisite notice and/or lapse of time, would entitle the lender to exercise its remedies, including foreclosing on ICP’s assets and, in the case of the working capital deficiency or successive losses, enforcing the plant closure provisions in the Limited Liability Company Agreement referred to above. The loans are non-recourse to us.

 

D.M. Ingredients GmbH.  On July 2, 2007 we acquired a 50% interest in D.M. Ingredients, GmbH, a German joint venture company which produces certain MGPI specialty ingredients products

 

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through a toller for distribution in the European Union (E.U.) and elsewhere.  As of June 30, 2010 our total capital commitment to the joint venture is $750, of which we had contributed $571.

 

ITEM 1A.  RISK FACTORS

 

Our business is subject to certain risks and uncertainties.  The following identifies those which we consider to be most important:

 

RISKS THAT AFFECT OUR BUSINESS AS A WHOLE

 

An interruption of operations at our Atchison facility could negatively affect our business.

 

Following the cessation of our operations at our former Pekin plant (which is now owned by a 50% owned joint venture, ICP, the bulk of our Ingredient Solutions and food grade alcohol production takes place at our facility in Atchison.  An interruption in or loss of operations at this facility, or a strike by our unionized employees at this location, could reduce or postpone production of our products, which could have a material adverse effect on our business, results of operations and/or financial condition.  To the extent that our value-added products rely on unique or proprietary processes or techniques, replacing lost production by purchasing from outside suppliers becomes more difficult.

 

Our profitability is affected by the cost of natural gas and of grain and flour that we use in our business, the availability and cost of which are subject to weather and other factors beyond our control.  Our hedging strategy may not protect us from changes in prices of commodities and natural gas or translate to a competitive advantage in the marketplace.

 

Grain and flour costs are a significant portion of our costs of goods sold. Historically the cost of such raw materials has been subject to substantial fluctuations, depending upon a number of factors which affect commodity prices in general and over which we have no control.  These include crop conditions, weather, government programs and purchases by foreign governments. The price of natural gas, which comprised approximately 8 percent of our cost of goods sold in fiscal 2010 and 12 percent of our cost of goods sold in fiscal 2009, also fluctuates, based on anticipated changes in supply and demand, weather and the prices of alternative fuels.   Fluctuations in the price of commodities and natural gas can be sudden and volatile at times and have had, from time to time, significant adverse effects on the results of our operations.

 

Formerly, we engaged in the purchase of commodity and natural gas futures and options and in the forward purchases of grain and natural gas to hedge economic risks associated with fluctuating grain and natural gas prices.   We no longer engage in such activities based on expected use of our facilities, and now intend to purchase derivatives and enter contracts for future delivery only to protect margins on contracted alcohol sales and expected ingredients sales.   On the portion of purchases not hedged, management will attempt to recover higher commodity costs through higher sales prices, but market considerations may not always permit this.  Even where prices can be adjusted, there would likely be a lag between when we incur higher commodity or natural gas costs and when we might be able to increase prices.  To the extent we do not enter such derivative contracts or engage in forward purchases and are also unable to timely adjust the prices we charge under sales contracts, we may be adversely impacted by market fluctuations in the cost of grain and natural gas.

 

If ICP incurs losses, it could result in closure of its Pekin plant. This could result in increased costs and impairment losses for us.

 

ICP’s limited liability company agreement gives us and our joint venture partner, ICP Holdings, a subsidiary of Seacor Energy Inc., certain rights to shut down the Pekin plant if ICP operates at an EBITDA loss of $500 in any quarter.  Such rights are conditional in certain instances but are absolute if losses aggregate $1,500 over any three consecutive quarters or if ICP’s net working capital is less than $2,500. Losses of such nature are also events of default under ICP’s term loan and revolving credit agreements with

 

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its lender, an affiliate of SEACOR Energy, Inc., which, upon any requisite notice and/or lapse of time, would entitle the lender to impose a default rate of interest, foreclose on ICP’s assets and, in the case of the working capital deficiency or successive losses, enforce the closure provisions referred to above.  We believe that these provisions were not drafted with start up of operations in mind.   ICP experienced losses exceeding the $500 quarterly threshold amount in the quarter ending December 31, 2009 and the quarter ending March 31, 2010; however, it recouped a portion of these losses in the quarter ended June 30, 2010.   Neither we nor, to our knowledge, ICP Holdings presently intends to exercise termination rights as a result of ICP’s start-up losses, and ICP’s lender has waived the defaults resulting from the breaches of the covenant related to quarterly losses in excess of $500.  However, if future losses of the requisite magnitudes occur, either we, ICP Holdings or ICP’s lender may elect to exercise its rights under the applicable agreement.  In this event, we could be forced to purchase alcohol from third parties at unfavorable prices to satisfy contractual commitments to our customers.  We also might incur impairment losses with respect to our remaining investment in ICP if the plant were closed and/or ICP’s lender accelerated its debt and foreclosed on its collateral.

 

We have incurred impairment and restructuring losses in the past and may suffer such losses in the future.

 

We review long-lived assets for impairment at year end or if events or circumstances indicate that usage may be limited and carrying values may not be recoverable. Should events indicate the assets cannot be used as planned, the realization from alternative uses or disposal is compared to their carrying value. If an impairment loss is measured, this estimate is recognized. Considerable judgment is used in these measurements, and a change in the assumptions could result in a different determination of impairment loss and/or the amount of any impairment. See Item 7. Managements’ Discussion and Analysis of Financial Condition and Results of Operations — Critical Accounting Estimates.

 

The markets for our products are very competitive, and our results could be adversely affected if we do not compete effectively.

 

The markets for products in which we participate are very competitive. Our principal competitors in these markets have substantial financial, marketing, and other resources, and several are much larger enterprises than us. Competition is based on such factors as product innovation, product characteristics, product quality, price, color and name.  If market conditions make our specialty ingredients too expensive for use in consumer goods, our revenues could be affected.  If our large competitors were to decrease their pricing, we could choose to do the same, which could adversely affect our margins and profitability.   If we did not do the same, our revenues could be adversely affected due to the potential loss of sales or market share. Our revenue growth could also be adversely impacted if we are not successful in developing new ingredients products for our customers or through new product introductions by our competitors.  In addition, more stringent new customer demands may require us to make internal investments to achieve or sustain competitive advantage and meet customer expectations.

 

If we lose certain key personnel, we may not be successful.

 

We rely on the continued services of key personnel involved in management, finance, product development, sales, manufacturing and distribution, and, in particular, upon the efforts and abilities of our executive management team.  The loss of service of any of the members of our executive management team could have a material adverse effect on our business, financial condition and results of operations.  A loss of our CEO could result in the acceleration of the debt under our credit facility.  We do have key personnel life insurance covering two key executives, but this may not ensure avoidance of loss in that circumstance.

 

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Covenants and other provisions in our credit facility could hinder our ability to operate.  Our failure to comply with covenants in our credit facility could result in the acceleration of the debt extended under such facility, limit our liquidity and trigger other rights.

 

Our credit agreement with Wells Fargo Bank, National Association contains a number of financial and other covenants, including provisions that require us to meet certain financial tests and that may limit or restrict our ability to:

 

·                                          incur additional indebtedness;

·                                          pay dividends to stockholders or purchase stock;

·                                          make investments;

·                                          dispose of assets;

·                                          make needed capital expenditures;

·                                          create liens on our assets; or

·                                          merge or consolidate.

 

These covenants may hinder our ability to operate and could reduce our profitability, and a breach of any of these covenants or requirements could result in a default under our credit agreement.  Specific covenants require us to meet specified monthly, cumulative net income requirements, and require us to meet, as of fiscal year end, a minimum debt service coverage ratio.  See Managements Discussion and Analysis of Financial Condition and Results of Operations — Liquidity and Financial Resources — Financial Covenants.

 

In addition, our credit agreement permits the lender to modify or reduce the borrowing base at its sole (but reasonable) discretion and to accelerate our debt if an over-advance results.  Any modification to reduce our borrowing base or termination of our credit agreement would negatively impact our overall liquidity and may require us to take other actions to preserve any remaining liquidity.   Although we anticipate that we will be able to meet the covenants in our credit agreement, there can be no assurance that we will do so, as there are a number of external factors that affect our operations, such as commodity prices, over which we have little or no control.    If we default on any of our covenants, and if such default is not cured or waived, Wells Fargo could, among other remedies, terminate its commitment to lend and/or accelerate any outstanding debt and declare that such debt is immediately due and payable.  If Wells Fargo were to terminate our credit, or materially change our borrowing base, we may not have sufficient funds available for us to operate.  If it were to accelerate our debt, we might be unable to repay such debt immediately and might not be able to borrow sufficient funds to refinance.  Even if new financing were available, it may not be on terms that are acceptable to us.  Acceleration could result in foreclosure on assets that we have pledged to Wells Fargo.  Further, certain of our other secured debt instruments contain cross default provisions, such that an event of default under our credit agreement with Wells Fargo may result in an event of default under these other debt instruments.  If our lenders were to terminate our credit or accelerate our debt, or if Wells Fargo were to materially change our borrowing base, we might not have sufficient funds to operate.

 

We may require significant cash flow to make needed capital expenditures, and our ability to make such expenditures could be limited.

 

Over the course of the next few years we may need to make substantial capital expenditures.  See — Item 1. Business of the Company - Regulation and Item 7. Managements Discussion and Analysis of Financial Condition and Results of Operations — Liquidity and Capital Resources — Cash Flow Information — Investing Cash Flows.  During fiscal year 2011 for example, we intend to spend the majority of the capital required by the process water cooling system project elsewhere described.  Although Wells Fargo has granted an exemption from capital expenditure limitations under our credit facility for this project, we are still limited by the size of the line and must continue to meet our other covenants.  We may require additional long-term financing to meet certain of our capital expenditure requirements, but have not determined the amount, type or source of such financing.  Our credit facility generally prohibits new debt

 

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from other lenders and limits the amount of capital expenditures which we can make annually.  We would require the consent of Wells Fargo Bank to incur new debt and also may require the consent of Wells Fargo Bank to make other such needed expenditures.  We cannot provide assurances that we will be able to obtain such consent or arrange such financing on favorable terms, if at all.

 

We are subject to extensive regulation, and compliance with existing or future laws and regulations, including those relating to greenhouse gases and climate change, may require us to incur substantial expenditures or require us to make product recalls.

 

We are subject to a broad range of federal, state, local and foreign laws and regulations intended to protect public health and the environment.  Our operations are also subject to regulation by various federal agencies, including the Alcohol and Tobacco Tax Trade Bureau, the Occupational Safety and Health Administration, the Food and Drug Administration and the Environmental Protection Agency, and by various state and local authorities.  Such regulations cover virtually every aspect of our operations, including production facilities, marketing, pricing, labeling, packaging, advertising, water usage, waste water discharge, disposal of hazardous wastes and emissions and other matters.  Violations of any of these laws and regulations may result in administrative, civil or criminal penalties being levied against us, revocation or modification of permits, performance of environmental investigatory or remedial activities, voluntary or involuntary product recalls, or a cease and desist order against operations that are not in compliance.  These laws and regulations may change in the future and we may incur material costs in our efforts to comply with current or future laws and regulations or to effect any product recalls.  These matters may have a material adverse effect on our business.  See Item 1. Business-Regulation, where we discuss certain environmental proceedings in which governmental agencies sought fines from us and required significant capital expenditures.

 

Our facility and our joint venture’s facility currently produce fuel grade alcohol as a by-product and emit carbon dioxide into the atmosphere as a by-product of the fermentation process. In 2007, the U.S. Supreme Court classified carbon dioxide as an air pollutant under the Clean Air Act in a case seeking to require the EPA to regulate carbon dioxide in vehicle emissions. On February 3, 2010, the EPA released its final regulations on the Renewable Fuel Standard program (RFS2).  We believe these final regulations grandfather both facilities at their current operating capacity for fuel grade alcohol, but plant expansion would need to meet a 20% threshold reduction in greenhouse gas emissions from a 2005 baseline measurement to produce fuel grade alcohol eligible for the RFS2 mandate.  Additionally, legislation is pending in Congress on a comprehensive carbon dioxide regulatory scheme, such as a carbon tax or cap-and-trade system. We may be required to install carbon dioxide mitigation equipment or take other steps unknown to us at this time in order to comply with other future laws or regulations. Compliance with future laws or regulations relating to emission of carbon dioxide could be costly and may require additional working capital, which may not be available, preventing us and our joint venture from operating our plants as originally designed, which may have a material adverse impact on our respective operations, cash flows and financial position.

 

RISKS SPECIFIC TO OUR DISTILLERY PRODUCTS SEGMENT

 

Volatile corn prices affect our profitability.

 

A portion of our operating income is dependent on the spreads between alcohol and corn prices.  We intend to protect the margins on our alcohol contracts, but may not always be able to do so.  If we are not successful in protecting our margins through hedging activities, volatility in corn prices could affect our profitability.

 

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The relationship between the price we pay for corn and the sales prices of our distillery co-products can fluctuate significantly and affect our results of operations.

 

Dried grain, or distillers feed, and fuel grade alcohol are the principal co-products of our alcohol production process and can contribute in varying degrees to the profitability of our distillery products segment.  We sell fuel grade alcohol, the prices for which typically, but not always, have tracked price fluctuations in gasoline prices.  Distillers feed is sold for prices which historically have tracked the price of corn.  In fiscal 2009 and 2008, however, the value of these co-products lagged behind the significant and rapid increase in corn prices.  In regard to distillers feed, we believe that, in part, this resulted from decreased demand in the E.U. due to the E.U.’s non-approval of several varieties of genetically modified corn commonly grown in the U.S. Further, certain of our co-products compete with similar products made from other plant feedstocks whose cost may not have risen in unison with corn prices.  As a result, the profitability of these products to us could be affected.

 

Although we have reduced our own production of fuel grade alcohol, we continue to have some exposure to fuel grade alcohol market price fluctuations through our ICP joint venture.

 

Because of the continued erosion of the fuel alcohol markets, in the prior fiscal year we determined to substantially reduce our production of fuel alcohol and temporarily ceased production at our former Pekin facility.  Subsequently, after exploring our strategic options with respect to this facility, we contributed the facility to ICP and sold a 50% interest in ICP to ICP Holdings. We purchase food grade and industrial use alcohol products from ICP and market and sell such products, and SEACOR Energy, Inc. has a similar arrangement with respect to fuel grade alcohol.   Although we have reduced our exposure to the volatility of the fuel grade alcohol business through this arrangement, because we share in the profits and losses of ICP, we retain some exposure to such volatility.

 

RISKS SPECIFIC TO OUR INGREDIENT SOLUTIONS SEGMENT

 

Business Strategy Risks

 

Our business strategy for our ingredient solutions segment includes focusing our efforts on the sale of specialty proteins and starches to targeted domestic consumer packaged goods customers.  Our food ingredients receiving major focus and which are primarily used in foods that are developed to address consumers’ desire for healthier and more convenient products consist of dietary fiber, wheat protein isolates and concentrates, and textured wheat proteins   The bulk of our applications technology and research and development efforts are dedicated to providing customers with specialty ingredient solutions that deliver nutritional benefits, as well as desired functional and sensory qualities to their products.  Our business could be adversly affected if our customers were to determine to reduce their new product development (NPD) activities or ceased using our unique dietary fibers, starches and proteins in their NPD efforts. In addition, our sales growth opportunities could be at risk in these areas if consumers abandon or significantly limit their interest in healthier foods, abandon or limit their interest in convenience foods, and/or adopt a widespread aversion to foods containing wheat gluten.

 

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The contracted production of our Wheatex® product ends in August 2012, and our continued production and sales of this product depend on extending the contract or finding an economical production alternative.

 

When we sold our Pet Products business and Kansas City, Kansas plant, we leased a portion of the plant from the purchaser and contracted with the purchaser to manufacture Wheatex® using certain production equipment which we retained.  The term of these arrangements expire in August 2012.  Our continued profitable commercialization of this product will require us to either extend our arrangement with the purchaser on terms comparable to those we have at present, identify an alternative source of production or produce the product in house.  There can be no assurance that we will be able to extend our arrangement on comparable terms or that we will be able to identify an alternative source of production.  Moving the equipment to another location may require significant expenditures, and our ability to make the necessary expenditures to move the equipment and produce this product in house may be limited by provisions in our credit facility.  See “We may require significant cash flow to make needed capital expenditures, and our ability to make such expenditures could be limited.”

 

RISKS SPECIFIC TO OUR OTHER SEGMENT

 

Our plant-based biopolymers and wood-based composite resins may not prove to be profitable or commercially scalable.

 

Plant-based biopolymers and wood- based resins continue to represent an emerging area of our business.   While commercialization of these products has begun, they continue to undergo further research and development as we explore additional enhancements to expand their functionality and use capabilities.  To date, they have not contributed significant revenues or profit.

 

OTHER RISKS

 

Common stockholders have limited rights under our Articles of Incorporation.

 

Under our Articles of Incorporation, holders of our Preferred Stock are entitled to elect five of our nine directors and only holders of our Preferred Stock are entitled to vote with respect to a merger, dissolution, lease, exchange or sale of substantially all of the Company’s assets, or on an amendment to the Articles of Incorporation, unless such action would increase or decrease the authorized shares or par value of the Common or Preferred Stock, or change the powers, preferences or special rights of the Common or Preferred Stock so as to affect the holders of Common Stock adversely.  Generally, the Common Stock and Preferred Stock vote as separate classes on all other matters requiring stockholder approval.  A majority of the outstanding shares of our Preferred Stock is held by the MGP Ingredients Voting Trust, whose trustees are Cloud L. Cray, Jr., Richard B. Cray and Laidacker M. Seaberg.

 

The trading volume in our common stock fluctuates, and depending on market conditions, the sale of a substantial number of shares in the public market could depress the price of our stock and make it difficult for stockholders to sell their shares.

 

Our common stock is listed on the NASDAQ Stock Market.  Our public float at June 30, 2010 was approximately 11,630,694 shares, as approximately 5,888,920 shares are held by affiliates.  Over the twelve months ended June 30, 2010, our daily trading volume as reported to us by NASDAQ has fluctuated from 3,100 to 504,724 shares (excluding block trades).  When trading volumes are relatively light, significant price changes can occur even when a relatively small number of shares are being traded and an investor’s ability to quickly sell quantities of stock may be affected.

 

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ITEM 1B.  UNRESOLVED STAFF COMMENTS

 

None

 

ITEM 2.  PROPERTIES

 

We own or lease the following principal plants, warehouses and office facilities:

 

Location

 

Purpose

 

Owned or
Leased

 

Plant Area
(in sq. ft.)

 

Tract Area
(in acres)

 

 

 

 

 

 

 

 

 

Atchison, Kansas

 

Grain processing, distillery, warehousing, and research and quality control laboratories (Distillery Products and Ingredient Solutions)

 

Owned

 

494,640

 

26

 

 

 

 

 

 

 

 

 

 

 

Principal executive office building (Corporate)

 

Leased

 

18,000

 

1

 

 

 

 

 

 

 

 

 

 

 

Technical Innovation Center (Ingredient Solutions, Distillery Products and Other))

 

Leased

 

19,600

 

1

 

 

 

 

 

 

 

 

 

Kansas City, Kansas

 

Specialty proteins (Ingredient Solutions)

 

Leased

 

27,400

 

N/A

 

 

 

 

 

 

 

 

 

Onaga, Kansas

 

Production of plant-based polymers and wood composites (Other)

 

Owned

 

23,040

 

3

 

Our 50% owned joint venture subsidiary, ICP, owns the following facility.

 

Pekin, Illinois

 

Distillery, warehousing and quality control laboratories (Distillery Products)

 

Owned

 

462,926

 

49

 

The foregoing facilities are generally in good operating condition, and are generally suitable for the business activity conducted therein.  We operated our Atchison distillery operations at full capacity during much of fiscal 2010. We have existing manufacturing capacity to grow our ingredients business at our Atchison plant if the market for our ingredients business improves.   Our former Pekin distillery operation, which we shut down in February 2009, is now owned by ICP.  This plant was reactivated in the third quarter of fiscal 2010 and was operating at approximately 75% of capacity at fiscal year end.

 

We formerly owned an 83,200 square foot facility in Kansas City, Kansas, but sold it on August 21, 2009.  We are now leasing a portion of that facility for three years ending in August 2012.  We have equipment used for the production of our Wheatex® line of products at this location, which is operated by a third party under a toll manufacturing agreement with us.

 

All of the other production facilities that we or ICP utilize are owned, and all of our owned properties are subject to mortgages in favor of one or more of our lenders.  The executive offices and

 

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technical innovation center in Atchison are leased from the City of Atchison pursuant to an industrial revenue bond financing. Our leasehold interest in these properties is subject to a leasehold mortgage.  We also own or lease transportation equipment and facilities and a gas pipeline described under Business — Transportation and Energy.  Our loan agreements contain covenants that limit our ability to pledge our facilities to others.

 

ITEM 3.  LEGAL PROCEEDINGS

 

In 2006, we entered a Consent Agreement with the Kansas Department of Health and Environment (KDHE) which, among other matters, imposed a source-wide, rolling 12-month volatile organic compounds (VOC) emissions cap on our Atchison facility.  We anticipated that it would exceed this cap during the fourth quarter of fiscal 2010 and negotiated a second amendment to the Consent Agreement with the KDHE. (A prior amendment addressed an earlier instance of noncompliance with the emission limit and related testing, monitoring and permitting violations and assessed a civil penalty of $66 against us).  The second amendment requires us to complete a closed-loop, process cooling water system project, resulting in significant VOC reduction, in accordance with a scheduled timeline extending over an approximate seventeen month period which ends on September 30, 2011.  In addition, we agreed to a $5 per month penalty for any month that we exceed the rolling 12-month cap, as well as a $1 per day penalty for each day we exceed established completion dates for various stages of the project. We have commenced an $8,500 capital project that will involve the installation of a new system designed to meet KDHE VOC emission standards.

 

ITEM 4.  (REMOVED AND RESERVED)

 

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ITEM 4A.  EXECUTIVE OFFICERS OF THE REGISTRANT

 

Our Executive Officers are as follows:

 

Name

 

Age

 

Position

 

 

 

 

 

Timothy W. Newkirk

 

42

 

President and Chief Executive Officer

 

 

 

 

 

Don Tracy

 

53

 

Vice President, Finance and Chief Financial Officer

 

 

 

 

 

Donald G. Coffey, Ph.D.

 

55

 

Executive Vice President, Sales and Marketing and Research, Development and Innovation

 

 

 

 

 

Clodualdo “Ody” Maningat, Ph.D.

 

55

 

Vice President, Application Technology and Technical Services

 

 

 

 

 

Marta L. Myers

 

50

 

Corporate Secretary and Executive Assistant to the President and Board Chairman

 

 

 

 

 

Steven J. Pickman

 

57

 

Vice President, Corporate Relations and Marketing Services

 

 

 

 

 

David E. Rindom

 

55

 

Vice President, Human Resources

 

 

 

 

 

Randy M. Schrick

 

60

 

Vice President, Engineering of MGP Ingredients, Inc. and President of ICP

 

Mr. Newkirk has served as President and Chief Executive Officer since March, 2008.  He previously had been President and Chief Operating Officer since October, 2006 and Vice President of Operations and Chief Operating Officer since April, 2006.  He first joined the Company in 1991, serving initially as a distillery shift manager and later as a process engineer, project engineer and quality control manager at the Atchison, Kansas plant.  He became manager of the Company’s Pekin, Illinois plant in 1997.  From 2000 to 2002, he was Vice President of Operations for the former High Plains Corporation, a fuel grade alcohol production company located in Wichita, Kansas.  He became Vice President of Global Operations for Abengoa Bioenergy S.L. following that company’s acquisition of High Plains in January, 2002.  He then served as Chief Operating Officer of Abengoa Bioenergy Corporation from August, 2003 until his return to MGP Ingredients as Director of Operations in 2005.

 

Mr. Tracy has served as Vice President of Finance and Chief Financial Officer of MGP Ingredients, Inc. since November 2009. From 2007 until joining the Company, he served as Chief Financial Officer at Emery Oleochemicals, a global chemical manufacturer, and was based in Cincinnati.  Prior to his position at Emery Oleochemicals, Mr. Tracy served as Chief Financial Officer at Briggs Industries, a worldwide manufacturer and distributor of kitchen and bath fixtures, at the company’s U.S. headquarters in Charleston, South Carolina, from 2005 to 2007.  Before that, he spent four years with the Tenaris Corp., a global producer of steel tubes, where he began as Director of Financial Projects and subsequently was promoted to Chief Financial Officer of Tenaris, North America. Mr. Tracy’s previous experience included serving as Senior Vice President of the process improvement group of National City Corporation, Cleveland, from 1999 to 2001; as a consultant at two large consulting firms from 1993 through 1998; and various positions with the Procter & Gamble Company from 1983 to 1992.  From 1979 to 1981, he served as an Auditor with Deloitte & Touche.

 

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Dr. Coffey has served as Executive Vice President of Sales and Marketing, as well as Research, Development and Innovation since June 2009.   Prior to that, he had been Executive Vice President of the Company’s Ingredient Solutions segment since November 2008.  He joined the Company as Vice President of Innovation in July 2007.  He previously spent 22 years in commercialization and research positions with the Dow Chemical Co.  For 12 years beginning in 1985, he worked in the commercial and research operations of the METHOCEL business, a global business unit within Dow’s Special Chemical Group that manufactures cellulose derivatives for a variety of food and non-food applications.  He was later promoted to General Manager of Dow Food Stabilizers with responsibilities for global sales, marketing and research.

 

Dr. Maningat joined the Company in 1986.  He has served as Vice President of Application Technology and Technical Services since June 2002.  Previously, he was Corporate Director of Research and Development and Technical Marketing from 1997 to 2002.  He served as Corporate Director of Research and Development and Quality Control for the Company from 1993 to 1997.

 

Ms. Myers joined the Company in 1996.  She has served as Secretary since October 1996 and as Executive Assistant to the President since 1999.  Previously, she was executive secretary for Superintendent of Schools for Unified School District 409, Atchison, Kansas.

 

Mr. Pickman joined the Company in 1985.  He has served as Vice President, Corporate Relations and Marketing Services since June 2000.  Previously, he was Executive Director of Corporate Relations from 1999 to June 2000 and prior to that Corporate Director of Public and Investor Relations.  Between 1985 and 1989 he served as the Director of Public Relations and Marketing Administration for the Company’s former subsidiary, McCormick Distilling Company, Weston, Missouri, and for six years prior to that was Director of Public Relations at Benedictine College, Atchison.

 

Mr. Rindom joined the Company in 1980.  He has served as Vice President, Human Resources since June 2000.  He was Corporate Director of Human Relations from 1992 to June 2000, Personnel Director from 1988 to 1992, and Assistant Personnel Director from 1984 to 1988.

 

Mr. Schrick has served as President of Illinois Corn Processing, LLC, since November 2009.  He also has been Vice President of Engineering for MGP Ingredients since June 2009.  He previously had served as Corporate Director of Distillery Products Manufacturing from June 2008 to June 2009 and as Vice President, Manufacturing and Engineering from July 2002 to June 2008.  He served as Vice President - Operations from 1992 until July 2002.  From 1984 to 1992, he served as Vice President and General Manager of the Pekin plant.  From 1982 to 1984, he was the Plant Manager of the Pekin Plant subsequent to joining the Company in 1973.  Prior to 1982, he was Production Manager at the Atchison plant.  He was a Director of the Company from 1987 to 2008.

 

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PART II

 

ITEM 5.  MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDERS MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

 

TRADING MARKET

 

Our Common Stock is traded on the NASDAQ Global Select Market.  Our trading symbol is MGPI.

 

HISTORICAL STOCK PRICES

 

The table below reflects the high and low closing prices of our Common Stock for each quarter of fiscal 2010 and 2009:

 

 

 

 

Sales Price

 

 

 

 

High

 

Low

 

2010

 

 

 

 

 

 

 

First Quarter

 

$

4.39

 

$

2.29

 

 

Second Quarter

 

9.62

 

3.91

 

 

Third Quarter

 

7.78

 

6.36

 

 

Fourth Quarter

 

8.62

 

5.75

 

2009

 

 

 

 

 

 

 

First Quarter

 

$

6.35

 

$

2.84

 

 

Second Quarter

 

2.91

 

0.60

 

 

Third Quarter

 

0.96

 

0.50

 

 

Fourth Quarter

 

3.10

 

0.80

 

 

RECORD HOLDERS

 

At August 31, 2010, there were approximately 650 holders of record of our Common Stock.  We believe that the Common Stock is held by approximately 5,110  beneficial owners.

 

TRADING VOLUMES

 

According to reports received from the NASDAQ, the average daily trading volume of our common stock (excluding block trades) ranged from 3,100 to 504,724 shares during the fiscal year ended June 30, 2010.

 

DIVIDENDS

 

Our Credit Agreement with Wells Fargo Bank, National Association restricts our ability to pay cash dividends or make other distributions with respect to our stock.  We  may pay dividends only if (i) no default under the Credit Agreement has occurred or would occur as a result of the dividend, (ii) we have  had Average Excess Availability of not less than $10,000 for the 60 day period prior to such dividend, (iii) after giving effect to such dividend, we  have Average Excess Availability of not less than $5,000 and (iv) on the date of such dividend, we  have no accounts payable which remain unpaid more than thirty (30) days after the invoice date. “Average Excess Availability” generally means, as of any date of determination by lender, the average of the amount available for borrowing under the Credit Agreement, assuming, for purposes of calculation, that all accounts payable which remain unpaid more than sixty (60) days after the invoice date thereof as the close of business on such date are treated as additional advances outstanding on such date.

 

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Subject to the restrictions in our Credit Agreement, any dividends will be paid at the discretion of the Board of Directors, which will consider various factors, including our operating results and cash requirements, in making any decision regarding dividends.  We did not pay dividends in Fiscal 2009 or 2010.  However, on August 26, 2010, the Board of Directors declared a five (5) cent dividend per share of common stock, payable October 6, 2010 to holders of record on September 15, 2010.

 

PURCHASES OF EQUITY SECURITIES BY ISSUER

 

We did not repurchase any shares of our stock during the year ended June 30, 2010.

 

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ITEM 6. SELECTED FINANCIAL DATA (Dollars in thousands except per share amounts)

 

The selected financial data below (in thousands, expect per share amounts) should be read in conjunction with Management’s Discussion and Analysis of Financial Condition and Results of Operations included under Item 7 of this form 10-K as well as the consolidated financial statements and the related notes.

 

Fiscal Year (1) (2) (3) (4)(5)(6)(7)

 

2010

 

2009

 

2008

 

2007

 

2006

 

 

 

 

 

 

 

 

 

 

 

 

 

Statement of Operations Data:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net sales

 

$

201,971

 

$

291,812

 

$

412,473

 

$

382,306

 

$

335,215

 

Cost of sales

 

171,427

 

325,914

 

408,242

 

335,033

 

289,236

 

Gross profit (loss)

 

30,544

 

(34,102

)

4,231

 

47,273

 

45,979

 

 

 

 

 

 

 

 

 

 

 

 

 

Selling, general and administrative expenses

 

20,708

 

21,401

 

24,235

 

20,319

 

23,811

 

Other operating costs

 

2,018

 

4,694

 

 

 

 

Write-off of assets

 

 

 

1,546

 

 

 

Impairment of long-lived assets

 

 

10,282

 

8,100

 

 

 

Severance and early retirement costs

 

 

3,288

 

 

 

 

Loss on joint venture formation

 

2,294

 

 

 

 

 

Gain on sale of assets

 

(1,731

)

 

 

 

 

Other restructuring costs

 

 

5,241

 

 

 

 

Income (loss) from operations

 

7,255

 

(79,008

)

(29,650

)

26,954

 

22,168

 

Other income, net

 

645

 

112

 

515

 

1,490

 

137

 

Gain on settlement of litigation, net of related expenses

 

 

 

7,046

 

 

 

Interest expense

 

(1,757

)

(2,901

)

(1,490

)

(964

)

(1,482

)

Equity in loss

 

(2,173

)

(114

)

(14

)

 

 

Income (loss) before income taxes

 

3,970

 

(81,911

)

(23,593

)

27,480

 

20,823

 

 

 

 

 

 

 

 

 

 

 

 

 

Provision (benefit) for income taxes

 

(4,768

)

(12,788

)

(11,851

)

9,914

 

6,963

 

Net income (loss)

 

$

8,738

 

$

(69,123

)

$

(11,742

)

$

17,566

 

$

13,860

 

 

 

 

 

 

 

 

 

 

 

 

 

Basic earnings per common share

 

$

0.52

 

$

(4.17

)

$

(0.71

)

$

1.07

 

$

0.86

 

Diluted earnings per common share

 

$

0.51

 

$

(4.17

)

$

(0.70

)

$

1.04

 

$

0.83

 

Weighted average basic common shares outstanding

 

16,655

 

16,585

 

16,531

 

16,428

 

16,106

 

Weighted average diluted common shares outstanding

 

17,082

 

16,585

 

16,805

 

16,913

 

16,762

 

Cash dividends per common share

 

$

 

$

 

$

0.25

 

$

0.30

 

$

0.15

 

Balance Sheet Data:

 

 

 

 

 

 

 

 

 

 

 

Working capital

 

$

25,142

 

$

31,242

 

$

51,127

 

$

53,371

 

$

51,063

 

Total assets

 

121,137

 

145,132

 

223,068

 

221,121

 

202,594

 

Long-term debt, less current maturities

 

2,082

 

9,632

 

1,301

 

8,940

 

12,355

 

Stockholders’ equity

 

72,784

 

63,884

 

136,874

 

154,778

 

136,099

 

Book value per share

 

$

4.37

 

$

3.85

 

$

8.28

 

$

9.42

 

$

8.45

 

 

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(1)          Net sales and cost of sales for fiscal years 2006, 2007, 2008 and 2009 have been corrected to include customer paid freights costs billed to customers.  For further discussion, see Note 1 Nature of Operations and Summary of Significant Accounting Policies set forth in Item 8.

 

(2)          Fiscal year 2006 started on July 1 and ended June 30.  On June 8, 2006 the Board of Directors amended the Company’s Bylaws to effect a change in the fiscal year from a fiscal year ending June 30 to a 52/53 week fiscal year.  As a result of this change, fiscal 2007 ended on July 1, 2007.  On March 6, 2008, the Board of Directors amended the Company’s bylaws to effect a change in the fiscal year so that it would again end on June 30 each year.

 

(3)          Amounts for fiscal year 2008 include a write-off of assets of $1,546, a write-down of inventory of $1,300 and a loss on the impairment of assets of $8,100, partially offset by a gain on the settlement of litigation of $7,000 and the removal of a $3,000 state tax valuation allowance ($2,000 net of taxes).

 

(4)          Amounts for fiscal year 2009 include a non-cash loss on the impairment of assets of $10,282, severance and early retirement costs of $3,288, other restructuring costs of $5,241 and other operating costs related to our closed Pekin, Illinois plant of $4,694.  For further discussion, see Note 9 Restructuring Costs and Loss on Impairment of Assets set forth in Item 8, and Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations — Fiscal 2010 Compared to Fiscal 2009 — Cost of Sales.

 

(5)          Amounts for fiscal year 2010 include the impact of a correcting entry related to certain accounts payable recorded prior to fiscal 2010 that had been either duplicated or otherwise erroneously recorded.  The impact of the correcting adjustment increased reported pretax income by approximately $1,351.  Cost of sales was decreased by $733 and other income increased by $618.  For further discussion, see Note1 Nature of Operations and Summary of Significant Accounting Policies set forth in Item 8.

 

(6)          Amounts for fiscal year 2010 include a $2,294 charge related to the loss on joint venture formation. For further discussion, see Note 1 (Nature of Operations and Summary of Significant Accounting Policies) and Note 3 (Investment in Joint Ventures) set forth in Item 8, and Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations — Fiscal 2010 Compared to Fiscal 2009 - Loss on Joint Venture Formation.

 

(7)          Amounts for fiscal year 2010 include the impact of a tax law change that resulted in an income tax benefit of approximately $4,700.  For further discussion, see Note 9 Income Taxes and Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations — Fiscal 2010 Compared to Fiscal 2009 —  Income Taxes.

 

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ITEM 7.  MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Dollars in thousands except per-share amounts)

 

GENERAL

 

We produce certain ingredients and distillery products and have three reportable segments: an ingredient solutions segment, a distillery products segment and an other segment.  Substantially all of our sales are made directly or through distributors to manufacturers and processors of finished goods.  Sales to our customers purchasing food grade alcohol are made primarily on a spot, monthly or quarterly basis, with some annual contracts, depending on the customer’s needs and market conditions.  Sales of fuel grade alcohol are made on the spot market.  Contracts with distributors may be for multi-year terms with periodic review of pricing.  Contracts with ingredients customers are generally price and term agreements which are fixed for quarterly or six month periods, with very few agreements of twelve months duration or more.

 

Since the first quarter of fiscal 2009, we have made significant changes to our operations to improve our profitability.  We have refocused our business on the production of value-added ingredients and distillery products.  We have realigned our production efforts and taken steps to reduce excess inventories.  With our temporary ceasing of alcohol production at our Pekin facility in the third quarter of fiscal 2009 and its subsequent inclusion in a joint venture, we are selling reduced quantities of fuel grade alcohol as a co-product.  Sales of distillers feed also have decreased.  With the shutdown of our flour mill in Atchison in the second quarter of fiscal 2009, we no longer sell mill feeds.  We also ceased commodity starch and gluten production at our Pekin plant in the second quarter of fiscal 2009 and exited the personal care market in the third quarter of fiscal 2009.  In the first quarter of fiscal 2010, we sold our Kansas City, Kansas facility and pet-related business assets,   As a result of these actions, revenues across all segments have declined from historic levels; however, we experienced an improvement in our profit performance, primarily due to our improved sales mix of value-added products, lower costs of raw materials and natural gas, and lower costs from restructuring.

 

During the year ended June 30, 2009, we incurred impairment and restructuring costs, aggregating $18,811.  Products remaining within the ingredient solutions segment consist of starches, including specialty wheat starch and commodity wheat starch, and proteins, including specialty wheat proteins and commodity wheat gluten.  Commodity wheat starch and commodity wheat gluten are being produced on a limited basis consistent with our new focus on the production of value-added ingredients and distillery products.  Distillery products consist of food grade alcohol, including beverage alcohol and industrial-use alcohol, and fuel grade alcohol and distillers feed, which are co-products of our distillery operations.  Products in our other segment consist of plant-based biopolymers and wood-based composite resins.

 

In recent years, market economics for fuel grade alcohol have been volatile, and in the first calendar quarter of 2009 year we temporarily closed our Pekin plant.  After exploring our strategic alternatives with respect to the plant, in November 2009 we completed a series of related transactions pursuant to which we contributed our Pekin plant to a newly-formed company, ICP, and then sold 50 percent of the membership interest in ICP to ICP Holdings, an affiliate of SEACOR Energy Inc., for $15,000 ($13,951 net of closing costs).  ICP owns and operates the facility.  Under separate marketing agreements, we purchase beverage food grade alcohol products manufactured by ICP, and SEACOR Energy Inc. purchases fuel grade alcohol products manufactured by ICP.  These marketing agreements provide that we and ICP Holdings will share margin realized from the sale of the products with ICP. Through June 30, 2010 we paid higher prices than we expect to pay in future periods primarily due to lower than expected output during start-up of operations at ICP.

 

By entering the joint venture arrangement with ICP Holdings, we recovered a portion of our investment in the Pekin plant and enhanced our ability to supply our food grade alcohol customers with quality product. Although we retain some exposure to the volatility of the fuel grade alcohol market through our investment in ICP, we have an opportunity to participate when the economics of that market are good, and we believe that the extent of our exposure to bad markets is significantly less than when we

 

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operated Pekin ourselves.  Further, we have the ability, through the termination provisions in the ICP limited liability company agreement, to limit our operating losses by causing ICP to shut down the plant if losses reach specified amounts.

 

Our principal raw materials are corn and flour.  Flour is processed into all of our products, and corn is processed into alcohol and animal feed.  The cost of raw materials is subject to substantial fluctuations depending upon a number of factors which affect commodity prices in general, including crop conditions, weather, government programs and purchases by foreign governments.  During fiscal 2010, the market prices for grain decreased substantially from fiscal 2009, whereas during fiscal 2009, the market prices for grain increased substantially from the prior year.  The average price for a bushel of corn that we paid in fiscal 2010 decreased by 24.1 percent from fiscal 2009.   The average price that we paid per bushel for wheat flour in fiscal 2010 was approximately 28.5 percent lower than in fiscal 2009.  We entered into our supply agreement with ConAgra Mills in November 2008, whereby it supplies wheat flour requirements for use in the production of protein and starch ingredients.  As a result, we no longer purchase wheat directly.  However, the price we pay ConAgra for flour is a function of the per-bushel cost of wheat and, accordingly, wheat prices continue to directly impact the cost of raw materials.  Based on market prices since June 30, 2010, we expect higher corn and flour prices in fiscal 2011 than in fiscal 2010.  We believe our focus on value-added products will reduce our risk to such price variations as larger profit margins related to such products can absorb higher levels of raw material volatility and as we may more readily seek adjustable price terms in contracts for such products. However, we may continue to be affected by price fluctuations to some degree.

 

Historically, in an attempt to minimize the effects of the volatility of raw material costs on operating profits, we have taken hedging positions by entering into contracts for future delivery or readily marketable exchange-traded commodity futures and option contracts to reduce the risk of future grain price increases.  However, we have changed our risk management program related to the volatility of raw material costs, and now only purchase derivatives or enter contracts for future delivery, and do not hedge these positions, in order to protect margins on contracted alcohol sales or expected ingredients sales.   To the extent we do not enter such contracts and are also unable to timely adjust the prices we charge under sales contracts, we may be adversely impacted by market fluctuations in the cost of grain and natural gas.  However, we believe our new program has less risk than our prior program.

 

We elected to discontinue the use of hedge accounting for all commodity derivative positions effective April 1, 2008.   Since April 1, 2008, we have recorded all changes in the value of derivatives in cost of sales in our Consolidated Statements of Operations.  See “Critical Accounting Policies” below.

 

Energy represents a major cost of operations, and seasonal increases in natural gas and other utility costs can affect our profitability.  Except for fiscal 2010 and 2007, in each fiscal year since fiscal 2002, energy costs have been higher than in the previous fiscal year.  We sometimes try to protect ourselves from increased energy costs by entering contracts for future delivery.  In fiscal 2009, we suffered $7,642 in losses from such a contract when we no longer required the gas that we contracted for following our decision to temporarily close our Pekin plant.

 

We have benefited from a United States Department of Agriculture program in effect from June 1, 2001 to May 31, 2003 to support the development and production of value-added wheat proteins and starches.  At June 30, 2010 and 2009, the deferred credit related to this grant was $5,379 and $6,190, respectively.  Current and prior period results reflect the recognition of revenue from this grant.  See Critical Accounting Policies” below.

 

During the second quarter of fiscal 2010, we identified an out-of period adjustment related to accounts payable that favorably impacted cost of sales and other income.  The impact to fiscal 2010 was an increase in reported pre-tax income for the year ended June 30, 2010 of approximately $1,351.  Cost of sales was favorably impacted by $733, and other income was improved by $618.  For further discussion, see Note 1 Nature of Operations and Summary of Significant Accounting Policies as set forth in Item 8.

 

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Table of Contents

 

CRITICAL ACCOUNTING POLICIES

 

In preparing financial statements, management must make estimates and judgments that affect the carrying values of our assets and liabilities as well as recognition of revenue and expenses.  Management’s estimates and judgments are based on our historical experience and management’s knowledge and understanding of current facts and circumstances.  The policies discussed below are considered by management to be critical to an understanding of our financial statements.  The application of certain of these policies places significant demands on management’s judgment, with financial reporting results relying on estimations about the effects of matters that are inherently uncertain.  For all of these policies, management cautions that future events rarely develop as forecast, and estimates routinely require adjustment and may require material adjustment.

 

Derivative and Hedging Activities.  Effective April 1, 2008, we elected to discontinue the use of hedge accounting for all commodity derivative positions.  Accordingly, changes in the value of derivatives subsequent to March 31, 2008 have been recorded in cost of sales in our Consolidated Statements of Operations.  Additionally, derivative instruments entered into subsequent to March 31, 2008 have not been designated as hedges. The change in the market value of these instruments also has been recorded in cost of sales in our Consolidated Statements of Operations.  Regardless of accounting treatment, we believe all commodity hedges are economic hedges.

 

Prior to April 1, 2008, from time to time, we entered into readily marketable exchange-traded commodity futures and option contracts to reduce the risk of future grain price increases.  We have changed our risk management program, and intend to only hedge to protect our anticipated margin in contracted alcohol sales and expected ingredients sales.  Derivative instruments related to our hedging program are recorded as either assets or liabilities and are measured at fair market value.  Consistent with application of hedge accounting under Financial Accounting Standards Board (“FASB) Accounting Standards Codification (“ASC”) Topic 815, Derivatives and Hedging, prior to April 1, 2008 changes in the fair market value of the derivative instruments designated as cash flow hedges were recorded either in current earnings or in other comprehensive income, depending on the nature of the hedged transaction.  Gains or losses recorded in other comprehensive income were reclassified into current earnings in the periods in which the hedged items were consumed.  Any ineffective portion of a hedged transaction was immediately recognized in current earnings.

 

USDA Grant.  We received a grant from the United States Department of Agriculture Commodity Credit Corporation totaling approximately $25,600 over the two-year period June 1, 2001 to May 31, 2003.  The funds were awarded for research, marketing, promotional and capital costs related to value-added wheat gluten and starch products.  Of the amount awarded, we allocated approximately $8,100 to operating costs and $17,500 to capital expenditures.  Management has exercised judgment in applying grant proceeds to operating costs and capital expenditures in accordance with the terms of the grant.  Funds applied to current operating costs were considered revenue as those costs were incurred during fiscal years 2002 and 2003.  Funds applied to capital expenditures are being recognized in income over the periods during which applicable projects are depreciated.  Substantially all of the remaining deferred credit of $5,379 will be recognized in this manner over approximately the next two to three years.

 

Impairment of Long-Lived Assets.  We review long-lived assets, mainly equipment, for impairment when events or circumstances indicate that usage may be limited and carrying values may not be recoverable.  In making such assessments, management must make estimates and judgments relating to anticipated revenues and expenses and values of our assets and liabilities.  Management’s estimates and judgments are based on our historical experience and management’s knowledge and understanding of current facts and circumstances.  Management derives data for its estimates from both outside and internal sources, and considers such matters as product mix, unit sales, unit prices, input costs, expected target volume levels in supply contracts and expectations about new customers as well as overall market trends.  Should events indicate the assets cannot be used as planned, the realization from alternative uses or disposal is compared to the carrying value.  If an impairment loss is measured, this estimate is recognized.  Considerable judgment is used in these measurements, and a change in the assumptions could result in a different determination of impairment loss and/or the amount of any impairment.  We recognized a non-

 

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cash impairment loss of $10,282 during the year ended June 30, 2009.  No events or conditions occurred during the year ended June 30, 2010 that required us to record an impairment.

 

Defined Benefit Retirement Plans.  We sponsor two funded, noncontributory qualified Defined Benefit Retirement Plans that cover substantially all our union employees at Atchison and former union employees at Pekin.  The benefits under these plans are based upon years of qualified credited service.  However, benefit accruals under both plans were frozen in the second quarter of 2010.  Our funding policy is to contribute annually not less than the regulatory minimum and not more than the regulatory maximum amount deductible for income tax purposes.  The measurement and valuation date of the plans is June 30 of each year.  We make various assumptions in valuing the liabilities and benefits under the plan each year.  We consider the rates of return on long-term, high-quality fixed income investments using the Citigroup Pension Liability Index as of June 30, 2010.  Assumptions regarding employee and retiree life expectancy are based upon the RP 2000 Combined Mortality Table.

 

Other Post-Retirement Benefits.  We also provide certain other post retirement health care and life insurance benefits to certain retired employees.  Currently, the plan covers approximately 223 participants, both active and retired.  The number of participants was reduced during fiscal 2010, in part due to our shutdown of the Pekin facility and the transfer of employees to our newly formed joint venture, ICP, as described elsewhere.  These actions caused a partial settlement and curtailment of our obligation for accrued retirement benefits.

 

We fund the post retirement benefit plans on a pay-as-you-go basis and there are no assets that have been segregated and restricted to provide for post retirement benefits.  We pay claims as they are submitted for the medical plan.  We provide varied levels of benefits to participants depending upon the date of retirement and the location in which the employee worked.  The retiree medical and life plans are available to employees who have attained the age of 62 and rendered the required five years of service.  All health benefit plans provide company-paid continuation of the active medical plan until the retiree reaches age 65.  At age 65, we pay a lump sum advance premium on behalf of the retiree to the MediGap carrier of the retiree’s choice.  The employee retirement date determines which level of benefits is provided.

 

Our plan measurement date is June 30.  We make various assumptions in valuing the liabilities and benefits under the plan each year.  We consider the rates of return on currently available, high-quality fixed income investments, using the Citigroup Pension Liability Index as of June 30.  (Long term rates of return are not considered because the plan has no assets.)  For fiscal 2010, the accumulated post retirement benefit obligation (“APBO”) decreased to $8,170 from $8,799 at June 30, 2009.  A portion of the other post-retirement benefits obligation was settled for workers who were re-hired by ICP.  Assumptions regarding employee and retiree life expectancy are based upon the RP 2000 Combined Mortality Table.  We also consider the effects of expected long term trends in health care costs, which are based upon actual claims experience and other environmental and market factors impacting the cost of health care in the short and long-term.

 

Income Taxes.  We account for deferred income tax assets and liabilities resulting from the effects of transactions reported in different periods for financial reporting and income tax under the liability method of accounting for income taxes.  This method gives consideration to the future tax consequences of the deferred income tax items and immediately recognizes changes in income tax laws upon enactment as well as applied income tax rates when facts and circumstances warrant such changes.  We establish a valuation allowance to reduce deferred tax assets when it is more likely than not that a deferred tax asset may not be realized.  Additionally, we follow the provisions of FASB ASC 740, Income Taxes, related to the accounting for uncertainty in income tax positions, which requires management judgment and use of estimates in determining whether the impact of a tax position is “more likely than not” of being sustained on audit by the relevant taxing authority.  We consider many factors when evaluating and estimating our tax positions, which may require periodic adjustment and which may not accurately anticipate actual outcomes.  It is reasonably possible that amounts reserved for potential exposure could change significantly as a result of the conclusion of tax examinations and, accordingly, materially affect our operating results.

 

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Other Significant Accounting Policies.  Other significant accounting policies, not involving the same level of measurement uncertainties as those discussed above, are nevertheless important to an understanding of the financial statements.  These policies require difficult judgments on complex matters that are often subject to multiple sources of authoritative guidance.  See Note 1 Nature of Operations and Summary of Significant Accounting Policies set forth in Item 8 for other significant accounting policies.

 

DEVELOPMENTS IN THE INGREDIENT SOLUTIONS SEGMENT

 

In order to become more efficient and effective and to improve our results, we have refocused our business on our value-added products.  We believe the steps we have taken enabled us to return to profitability in fiscal 2010 and be more competitive, while allowing us to obtain financing that will enable us to maintain operations.

 

By substantially exiting the commodity wheat gluten business and curtailing our commodity starch production, we have significantly reduced sales volumes of our lower margin protein and starch products.  We continue to focus our manufacturing efforts on improving our consistency and capabilities for producing our higher margin specialty product lines.  We are using an on-line Customer Relationship Management (“CRM”) solution system that was implemented in fiscal 2009 to improve our ability to develop new sales of our product lines.  Our commercialization functions are focused on increasing sales growth of our specialty products to the largest and most innovative producers of consumer packaged goods in the U.S.

 

DEVELOPMENTS IN THE DISTILLERY PRODUCTS SEGMENT

 

As previously mentioned in Developments in the Ingredient Solutions Segment, in order to become more efficient and effective and to improve our results, we have refocused our business on the production and marketing of our value-added products.  We significantly reduced production of fuel grade alcohol and temporarily shut down our Pekin plant on January 29, 2009.  Consequently, fuel grade alcohol saw a decline in production volume of 82.1 percent for the year ended June 30, 2010.  However, the idling of Pekin had no effect on our food grade alcohol customers, as we continued to optimize food grade alcohol production capabilities at Atchison. Historically, we produced a majority of all of our food grade alcohol at Atchison and a majority of all of our fuel grade alcohol at Pekin.

 

One of the most important developments in the Distillery segment occurred in the second fiscal quarter, when we formed ICP, contributed our Pekin facility to ICP and sold off a 50 percent ownership interest in ICP, as elsewhere described.  ICP has allowed us to renew activity at the Pekin plant in a manner that utilizes the respective competencies of MGPI as a premier supplier of high quality food grade alcohol and SEACOR Energy Inc. as a leader in the energy and fuel markets.  In addition to realizing $13,951 (net of closing costs) of immediate value from a previously idle asset, the joint venture increases our available capacity of food grade alcohol.  ICP commenced production at the Pekin facility during the third quarter of fiscal 2010 and at June 30, 2010 was operating at approximately 75% of capacity.

 

On January 29, 2010, ICP purchased the steam production facility for the Pekin plant for approximately $5,000.  The Company and ICP Holdings each contributed $1,000 to acquire this asset and will fund the balance of the purchase price over the next two years.

 

DEVELOPMENTS IN THE OTHER SEGMENT

 

On August 21, 2009, we sold our Kansas City, Kansas, facility for $3,585, with potential additional payments based on the buyer’s income from sales of our existing products to our existing customers over the three years ending July 31, 2012.  The sale included all equipment used for the production and packaging of pet-related products, which principally include extruded plant-based resins and finished pet treats. We retained ownership of equipment that is used for the production of our Wheatex® textured wheat

 

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proteins, which are sold for use in meat extension and vegetarian product applications.  This equipment is located in a separate section of the facility that we have leased for a period of three years ending August 20, 2012 and which is operated by a subsidiary of the buyer under a toll manufacturing arrangement.

 

SEGMENT RESULTS

 

The following is a summary of revenues and pre-tax income (loss) allocated to each reportable operating segment for the two fiscal years ended June 30, 2010 and 2009 (See Note12 Operating Segments set forth in Item 8 for additional information regarding our operating segments).

 

 

 

2010

 

2009

 

 

 

 

 

 

 

Ingredient Solutions

 

 

 

 

 

 

 

 

 

 

 

Net Sales(1)

 

$

59,715

 

$

82,127

 

Pre-Tax Income (Loss)

 

9,731

 

(6,720

)

 

 

 

 

 

 

Distillery Products

 

 

 

 

 

 

 

 

 

 

 

Net Sales(1)

 

139,990

 

204,704

 

Pre-Tax Income (Loss)

 

16,713

 

(24,367

)

 

 

 

 

 

 

Other

 

 

 

 

 

 

 

 

 

 

 

Net Sales

 

2,266

 

4,981

 

Pre-Tax Income (Loss)

 

145

 

40

 

 


(1) Fiscal 2009 net sales for the segments have been corrected to include customer paid freight costs billed to customers.  For further discussion, see Note 1 Nature of Operations and Summary of Significant Accounting Policies set forth in Item 8.

 

The following table is a reconciliation between pre-tax income by segment and net income.

 

 

 

2010(1)

 

2009(1)

 

Income (loss) before income taxes

 

 

 

 

 

Ingredient solutions

 

$

9,731

 

$

(6,720

)

Distillery products

 

16,713

 

(24,367

)

Other

 

145

 

40

 

Corporate

 

(22,056

)

(24,411

)

Impairment of long-lived assets

 

 

(10,282

)

Severance and early retirement costs

 

 

(3,288

)

Loss on joint venture formation

 

(2,294

)

 

Gain on sale of assets

 

1,731

 

 

Other restructuring costs

 

 

(5,241

)

Unrealized loss on natural gas contract

 

 

(7,642

)

Total income (loss) before income taxes

 

3,970

 

(81,911

)

Provision (benefit) for income taxes

 

(4,768

)

(12,788

)

Net income (loss)

 

$

8,738

 

$

(69,123

)

 


(1)Non-direct selling, general and administrative, interest expense, investment income and other general miscellaneous expenses are classified as corporate.  Out-of-period adjustments are classified as corporate. In addition, we do not assign or allocate special charges to our operating segments.  For purposes of comparative analysis, loss on impairment of long-lived assets, severance and early retirement costs, loss on joint venture formation, gain on sale of assets, other restructuring costs, and the loss on natural gas contract for the years ended June 30, 2010 and 2009 have been excluded from our segments.

 

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FISCAL 2010 COMPARED TO FISCAL 2009

 

GENERAL

 

Consolidated earnings for the year ended June 30, 2010 increased compared to the year ended June 30, 2009 with earnings of $8,738 on consolidated sales of $201,971 versus a net loss of $69,123 on consolidated sales of $291,812 for the year ended June 30, 2009.  This increase in net earnings was primarily the result of our improved sales mix of value-added products, significantly decreased cost of sales resulting primarily from lower grain costs, and the absence of impairment, severance and restructuring costs that were recognized during the year ended June 30, 2009.  Along with the significant improvements we made in operating results, our fiscal 2010 net income benefitted from gains on the sale of assets previously written off, out of period adjustments, an income tax refund and reductions in our accrued pension and post-retirement liabilities, which aggregated $8,400.  These gains were largely offset by charges and costs associated with the formation and start-up of the ICP joint venture, as well as various costs related to restructuring and realignment, aggregating $6,700.  Restructuring costs related to the impairment of long lived assets, severance and other restructuring of $10,282, $3,288 and $5,241, respectively, were incurred for the year ended June 30, 2009.  Additionally, we incurred $7,642 in losses on a natural gas contract for our Pekin, Illinois production facility for the year ended June 30, 2009.

 

Earnings in the ingredients solutions segment increased over the same period in fiscal 2009 primarily due to an improved sales mix of value-added proteins and starches.  Lower wheat flour prices for our protein and starch processes were also a factor in our ingredient solutions segment performance.

 

INGREDIENT SOLUTIONS

 

Total ingredient solutions sales revenue for the year ended June 30, 2010 decreased by $22,412, or 27.3 percent, compared to the year ended June 30, 2009.  Revenues for commodity proteins and commodity starch decreased by $11,859 and $3,564, respectively, during this period.  Commodity proteins and starch products with lower margins were significantly reduced as a part of management’s strategy to focus on higher-margin, value-added products. Revenues for specialty starches for the year ended June 30, 2010 decreased overall $4,839, or 14.7 percent, compared to the year ended June 30, 2009, as a result of lower unit sales, partially offset by increased unit pricing.  However, sales of our fiber-enhancing resistant wheat starch and textured wheat proteins showed year-over-year increases.  Revenues for specialty proteins for the year ended June 30, 2010 decreased $1,089, or 5.0 percent, over the year ended June 30, 2009, as a result of lower unit sales.   While revenues for the ingredient solutions segment declined overall, margins improved during the year ended June 30, 2010 as a result of improved sales mix by reducing our emphasis on unprofitable product lines along with lower flour costs attributable to lower wheat prices.

 

Beginning in the quarter ended December 31, 2008, we entered into a supply contract for flour with ConAgra Mills whereby it is supplying our wheat flour requirements for use in the production of protein and starch ingredients.  As a result, we no longer purchase wheat directly. However, the price we pay ConAgra for flour is a function of the per-bushel cost of wheat and, accordingly, wheat prices continue to directly impact the cost of raw materials for our ingredient solutions segment. For the year ended June 30, 2010, the per-pound cost of flour decreased by 28.5 percent compared to the year ended June 30, 2009.

 

DISTILLERY PRODUCTS

 

Total distillery products sales revenue for the year ended June 30, 2010 decreased $64,714, or 31.6 percent, compared to the year ended June 30, 2009.  The majority of the decrease was attributable to the reduced production of fuel grade alcohol as a result of our decision to focus on food grade alcohol, which consistently has experienced more stable prices.  The decrease in revenues related to fuel grade alcohol was $40,373, or 85.1 percent, compared to the year ended June 30, 2009.  Distillers feed saw a decline in revenues of $18,720, or 56.6 percent, over the year ended June 30, 2009.   The decrease was largely due to the decrease in production of 38.0 percent compared to the year ended June 30, 2009, primarily resulting from the temporary shutdown of the Pekin facility and slightly lower unit pricing.  Also contributing to this

 

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decrease in revenue was food grade alcohol, which experienced a $5,621, or 4.5 percent, reduction in revenue from the year ended June 30, 2009.  The decrease was primarily attributable to lower per-unit pricing, which followed the decrease in corn prices during the year ended June 30, 2010.   While revenues for distillery products declined for the year ended June 30, 2010 as compared to a year ago, margins improved due to a significant reduction in sales of lower margin fuel grade alcohol, along with a significant reduction in corn and natural gas prices.  For the year ended June 30, 2010, the per-bushel cost of corn and the per-million cubic foot cost of natural gas averaged nearly 24.1 percent and 51.0 percent lower, respectively, than the year ended June 30, 2009.   These lower costs contributed to the fiscal 2010 profit for the segment.

 

OTHER PRODUCTS

 

For the year ended June 30, 2010, revenues for other products, consisting primarily of pet products and plant-based biopolymers, decreased $2,715, or 54.5 percent, compared to the year ended June 30, 2009.  The decline in other segment sales revenue was primarily the result of decreased unit sales of 92.7 percent for our pet products for the year ended June 30, 2010, compared to the prior fiscal year, offset by a slight increase in unit sales of our plant-based biopolymer products.  Although the sales performance in this segment declined compared to the prior year, the gross margins in this segment as a percent of sales improved substantially due to a reduction of pet product sales and increased focus on improving cost efficiencies in our eco-friendly biopolymer area. We sold the assets related to our pet products during the first quarter of fiscal 2010, as further described Note 10 Assets Held for Sale as set forth in Item 8.

 

NET SALES

 

Net Sales for the year ended June 30, 2010 decreased $89,841, or 30.8 percent, compared to the year ended June 30, 2009 as a result of decreased sales in all segments.   The decrease is primarily the result of our strategy to reduce sales of low and negative margin products across all operating segments and also partially to the adverse weather experienced during portions of the winter months of fiscal 2010.   Decreased sales in the ingredient solutions segment were related primarily to our exit from low margin commodity proteins and starch products. While unit pricing increased from a year ago for specialty starches and specialty proteins, lower unit sales of specialty starches and specialty proteins led to decreased sales in this segment.  Sales in the distillery products segment as a whole decreased primarily as a result of reduced volumes of fuel grade alcohol.  Revenues for food grade alcohol also declined as a result of unit pricing and decreased unit sales.  Revenues for distillers feed also declined as a result of lower unit sales.    Sales for our other segment decreased as the result of a decline in unit sales of pet products, which was partially offset by an increase in unit sales of biopolymer products.

 

Sales for fiscal 2009 have been corrected to include customer paid freight costs billed to customer.  For further discussion, see Note 1 Nature of Operations and Summary of Significant Accounting Policies set forth in Item 8.

 

COST OF SALES

 

For the year ended June 30, 2010, cost of sales decreased $154,487, or 47.4 percent, while sales decreased 30.8 percent compared to the year ended June 30, 2009.   This decrease in cost of sales was primarily the result of a fiscal 2009 charge taken to settle natural gas commitments, the change in operations at the Pekin plant, and reduced grain and energy costs.  The per-bushel cost of corn and the per-million cubic foot cost of natural gas averaged nearly 24.1 percent and 51.0 percent lower, respectively, than the year ended June 30, 2009.   The per pound cost of wheat flour for the year ended June 30, 2010 decreased by 28.5 percent compared to the year ended June 30, 2009.  For the year ended June 30, 2010, cost of sales was 84.9 percent of net sales, which generated a gross profit margin of 15.1 percent.  For the year ended June 30, 2009, cost of sales was 111.7 percent of net sales, which generated a gross margin of negative 11.7 percent.  Beginning in quarter ended December 31, 2008, we ceased purchasing and processing wheat into flour in favor of directly purchasing flour at a lower cost than our own manufacturing cost.  Cost of sales was favorably impacted $733 by an out-of-period adjustment.  See “General”, above.

 

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With the shutdown of protein and starch operations and the reduction and temporary idling of distillery operations at our Pekin plant, commitments for the purchase of natural gas through the remainder of the fiscal year 2009 under a single contract for our Pekin plant were in excess of projected consumption after adjusting for such reduced production.  We recorded a charge of $7,642 to cost of sales for unrealized losses for the year ended June 30, 2009 to cost of sales for losses realized upon settlement of this contract.

 

Cost of sales for fiscal 2009 has been corrected to include customer paid freight costs billed to customers.  For further discussion, see Note 1 Nature of Operations and Summary of Significant Accounting Policies set forth in Item 8.

 

SELLING, GENERAL AND ADMINISTRATIVE EXPENSES

 

Selling, general and administrative expenses for the year ended June 30, 2010 decreased $693, or 3.2 percent, compared to the year ended June 30, 2009. This decrease was primarily due to the reduction in the Company’s work-force which was a result of the restructuring along with other cost savings initiatives, partially offset by an increase in incentive compensation.

 

OTHER OPERATING COSTS

 

Other operating costs for the year ended June 30, 2010 decreased $2,676, or 57.0 percent, compared to the year ended June 30, 2009.  This decrease is primarily due to the reduction in costs associated with maintaining idle facilities.

 

IMPAIRMENT OF LONG LIVED ASSETS

 

For the year ended June 30, 2010, there were no impairments of long lived assets.  In fiscal 2009 material impairment charges were recorded in response to the losses incurred during the first quarter of fiscal 2009.  We took actions to return to profitability and included significant changes to operations as discussed below.

 

Ingredient Solutions Segment. On October 20, 2008 we announced that we had signed a non-binding letter of intent to acquire our flour requirements from a third party, were ceasing operations at our flour mill in Atchison, Kansas and were reducing our workforce by approximately 44 persons.  The workforce reduction consisted of a combination of temporary lay-offs and early retirement offers.  On November 6, we announced that the anticipated supply contract for flour had been signed, and the layoffs became permanent. Our decision to close our flour mill was due to the fact that we could no longer produce flour for our own use at costs that were competitive with those of third party producers.  As a result of this action, we performed an impairment analysis and recorded a $2,831 non-cash impairment charge in the Consolidated Statements of Operations in the second quarter of 2009 related to the flour mill assets.

 

On November 5, 2008 we announced plans to significantly reduce production of commodity wheat proteins and starches by ceasing protein and starch production operations at our Pekin, Illinois plant, effective November 12, 2008.  The majority of the Pekin facility’s protein and starch production consisted of gluten and commodity starches.  The action resulted in an additional work force reduction of approximately 80 persons, consisting of a combination of lay-offs and early retirement offers. As a result of the shutdown, we performed an impairment analysis and in the second quarter recorded a $4,960 non-cash impairment charge in the Consolidated Statements of Operations related to the Pekin protein and starch assets.  On January 29, 2009, we determined to cease the manufacture and sale of personal care ingredients products at our Atchison facility. We have completed the exit of the personal care line of products after fulfilling all obligations with respect to our personal care customers, completing all production and liquidating all remaining inventory.  As a result of this action, in the second quarter we incurred a non-cash impairment charge of $329 in the Consolidated Statements of Operation related to the write down of equipment used in the production of personal care products.

 

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In measuring for impairment of assets at our flour mill and our Pekin facility’s protein and starch production facility, management assumed no sales or other disposition but instead adjusted net values of these assets to zero as no further cash flow related to these assets was anticipated.

 

Distillery Segment.     In November of 2008, we determined to curtail fuel alcohol production at Pekin to approximately 30 million gallons annually until market conditions became more favorable.  Subsequent to December 31, 2008, we determined that we could further adjust our production process at Pekin in a way that permitted us to produce only minor quantities of fuel grade alcohol as a by-product of the production of food grade alcohol and determined to otherwise terminate the production of fuel grade alcohol. Subsequently, we determined to shut down food grade production at the plant for a temporary period. On March 31, 2009, we announced that we were considering strategic options for the Pekin plant.  We performed an impairment analysis of our other long lived assets and determined no further impairment charges were necessary as a result of these activities.

 

Other Segment.     At the end of the third quarter of fiscal 2008, we concluded that our pet business assets in the other segment and certain of our ingredient solutions segment assets in a mixed use facility in Kansas City, Kansas at which our pet treat resins are made were impaired.  At that time, we recorded an impairment charge of $8,100, of which $4,700 related to assets allocated to the Company’s other segment.  During the quarter ended December 31, 2008, management performed another test for impairment of these assets as a result of an appraisal resulting in a further charge of $811.  As part of our closing process for the quarter ended June 30, 2009, we performed an additional impairment test based upon then ongoing negotiations for the sale of the Kansas City facility and recorded an additional impairment charge of $1,351.  On August 21, 2009, we completed the sale of our Kansas City, Kansas facility for $3,585.

 

SEVERANCE AND EARLY RETIREMENT COSTS

 

For the year ended June 30, 2010, no severance and early retirement costs were incurred.  In connection with the production changes and impairment of long-lived assets described above and in Note 9. Restructuring Costs and Loss on Impairment of Assets, we also incurred $3,288 in severance related charges associated with early retirements and job eliminations during the year ended June 30, 2009.  These charges have been presented in the Company’s Consolidated Statements of Operations as “Severance and early retirement costs.”

 

LOSS ON JOINT VENTURE FORMATION

 

Loss on joint venture formation for the year ended June 30, 2010 was $2,294 compared to $0 for the year ended June 30, 2009.  The components included $1,245 to adjust the book value of the Pekin plant balance sheet assets contributed to the joint venture to the implied value and $1,049 for professional fees associated with the transactions.  We reduced our loss by $753 during the fourth quarter of fiscal 2010 related to the loss on joint venture formation when we recorded a settlement for the portion of the other post-retirement benefits obligation related to workers re-hired by ICP.

 

GAIN ON SALE OF ASSETS

 

Gain on sale of assets for the year ended June 30, 2010 was $1,731 compared to $0 for the year ended June 30, 2009.  The components include a $917 gain related to the sale of protein and starch equipment from the Pekin facility, a $671 gain related to the sale of certain flour mill assets, a $100 gain on the sale of transport equipment and a $43 gain on other equipment.

 

OTHER RESTRUCTURING COSTS

 

For the year ended June 30, 2010, other restructuring costs decreased $5,241, or 100.0 percent.  In connection with the production changes and impairment of long-lived assets described in Note 9  Restructuring Costs and Loss on Impairment of Assets set forth in Item 8, we incurred a $2,185 net loss

 

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during the quarter ended December 31, 2008, which is net of approximately $1,109 in realized gains previously recorded in accumulated other comprehensive income.

 

In addition, during fiscal 2009 we recognized $2,925 in lease termination costs which we expected to incur with respect to rail cars which we formerly used to transport flour and whose leases expire through 2013. We recognized this expense because we no longer utilized these cars in our business.  Expected payments accrued reflect the net present value of the remaining obligation for unused cars net of units which are estimated to be returned to the lessor sooner than the lease termination date.  The discount rate used was 6.4 percent, which was consistent with the rate provided by our actuary.  We estimated that the remaining railcars would be returned to the lessor or assigned to other third parties over the course of four years.

 

During fiscal 2010, 53 railcars were returned to the lessor.  We expect the remaining 68 railcars will be returned during fiscal 2014.  Activity related to the liability for restructuring is further described in Note 9 Restructuring Costs and Loss on Impairment of Assets set forth in Item 8.

 

OTHER INCOME, NET

 

Other income, net, increased $533, or 475.9 percent, for the year ended June 30, 2010 compared to the year ended June 30, 2009.  This increase was primarily attributable to a non recurring reversal of account payable balances related to a prior period totaling $618, as further described in Note 1 Nature of Operations and Summary of Significant Accounting Policies set forth in Item 8.  This increase was partially offset by changes in interest capitalized as well as the effect of certain other non-recurring revenue items.

 

INTEREST EXPENSE

 

Interest expense for the year ended June 30, 2010 decreased $1,144 compared to the year ended June 30, 2009.  This decrease arose from lower line of credit balances and other corporate borrowings compared to the same periods in the prior year, as a result of improvements in operating cash flow, proceeds from asset sales and income tax refunds.

 

EQUITY IN LOSS OF JOINT VENTURES

 

ICP

 

On November 20, 2009, we completed a series of transactions whereby we contributed our Pekin plant to a newly-formed company, ICP, and then sold 50 percent of the membership interest in ICP to ICP Holdings, an affiliate of SEACOR Energy Inc., for a purchase price of $15,000 ($13,951 net of closing costs) as further described in Note 3 Investment in Joint Ventures set forth in Item 8.

 

For the period from November 20, 2009 to June 30, 2010, ICP incurred a net loss of $4,051, primarily related to costs incurred as part of the initial implementation of operations.  As a 50 percent joint venture holder, our portion of the loss was $2,026.

 

D.M. Ingredients, GmbH (“DMI”)

 

On July 17, 2007, we completed a transaction with Crespel and Deiters GmbH & Co. KG for the formation and financing of a joint venture, DMI, located in Ibbenburen, Germany.  DMI’s primary operation is the production of specialty ingredients for marketing by MGPI domestically and, through our partner and third parties, internationally.  Currently, the joint venture is utilizing a third party toller in the Netherlands to produce the products.  We own a 50 percent interest in DMI, and account for it using the equity method of accounting.  As of June 30, 2010, we had invested $571 in DMI since July 2007.

 

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For the year ended June 30, 2010, DMI incurred a net loss of $293 related to costs incurred as part of the initial implementation of operations.  No sales revenue was reported.  As a 50 percent joint venture holder, our equity in this loss was $147 and $114 for fiscal 2010 and 2009, respectively.

 

DMI’s functional currency is the European Union Euro.  Accordingly, changes in the holding value of the Company’s investment in DMI resulting from changes in the exchange rate between the U.S. Dollar and the European Union Euro are recorded in other comprehensive income as a translation adjustment on unconsolidated foreign subsidiary net of deferred taxes.

 

INCOME TAXES

 

For the year ended June 30, 2010, we had an income tax benefit of $4,768, resulting in an effective rate of negative 120.1 percent.  For the year ended June 30, 2009, our income tax benefit was $12,788, for an effective rate of 15.6 percent.

 

For the year ended June 30, 2010, the effective rate differs from our statutory rate primarily due to changes in the federal and state valuation allowance and the benefit of a tax law change occurring during fiscal 2010.  Under the Worker, Homeownership, and Business Assistance Act of 2009, which was enacted during the second quarter of fiscal 2010, we became eligible to carry back net operating losses generated in our fiscal year ended June 30, 2009 to our five preceding tax years, instead of the two years allowed under previous tax law.  We filed a claim to carry an additional $11,900 of net operating loss back.  An income tax benefit of approximately $4,700 was recognized during the second quarter of fiscal 2010 related to this carryback claim.  The cash refund associated with the carryback claim was received during January 2010.  For further discussion on the deferred income tax valuation allowance, see Note 5 Income Taxes set forth in Item 8.

 

NET INCOME

 

As the result of the factors outlined above, we experienced net income of $8,738 for the year ended June 30, 2010, compared to a net loss of $69,123 for the year ended June 30, 2009.  See “General”, above.

 

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QUARTERLY FINANCIAL INFORMATION

 

Our sales have not been seasonal during fiscal years 2010 and 2009. The table below shows quarterly information for each of the years ended June 30, 2010 and 2009.

 

Quarter

 

1st Quarter

 

2nd Quarter

 

3rd Quarter

 

4th Quarter

 

Total

 

(dollars in thousands, except per
share amounts)

 

 

 

 

 

 

 

 

 

 

 

Fiscal 2010(1)(2) (3) (4)

 

 

 

 

 

 

 

 

 

 

 

Net sales

 

$

50,249

 

$

48,094

 

$

49,269

 

$

54,359

 

$

201,971

 

Gross profit

 

9,837

 

8,510

 

4,967

 

7,230

 

30,544

 

Net income (loss)

 

3,738

 

4,778

 

(2,254

)

2,476

 

8,738

 

Earnings (loss) per share (diluted)(8)

 

$

0.22

 

$

0.28

 

$

(0.14

)

$

0.14

 

$

0.51

 

 

 

 

 

 

 

 

 

 

 

 

 

Fiscal 2009 (1) (5) (6) (7)

 

 

 

 

 

 

 

 

 

 

 

Net sales

 

$

104,620

 

$

77,483

 

$

57,476

 

$

52,233

 

$

291,812

 

Gross profit (loss)

 

(16,687

)

(23,648

)

91

 

6,142

 

(34,102

)

Net loss

 

(17,243

)

(42,716

)

(6,248

)

(2,916

)

(69,123

)

Loss per share (diluted)(8)

 

$

(1.04

)

$

(2.58

)

$

(0.38

)

$

(0.18

)

$

(4.17

)

 


(1)

Sales have been corrected to include customer paid freights costs billed to customers for the 1st, 2nd and 3rd quarters of fiscal 2010 and for all quarters for fiscal 2009. For further discussion, see Note 1 Nature of Operations and Summary of Significant Accounting Policies set forth in Item 8.

(2)

Net income for the first quarter of fiscal 2010 includes a $200 gain on the sale of certain flour mill assets and transport equipment.

(3)

Net income for the second quarter of fiscal 2010 includes a $3,047 charge related to the loss on joint venture formation and a $500 gain on the sale of certain flour mill assets. The second quarter of fiscal 2010 also included an out-of period adjustment related to a reduction of accounts payable that increased pretax income by $1,351. See (4) below related to the $3,047 charge.

(4)

Net income for the fourth quarter of fiscal 2010 includes a $753 out-of-period adjustment related to a partial settlement and a curtailment of the other post-retirement plan which was a favorable impact to pretax income. Had this adjustment been recorded in the proper quarter, pretax income would have been favorably impacted by $753 for the second quarter of fiscal 2010. This adjustment reduced the loss on joint venture formation recorded during the second quarter of fiscal 2010 from $3,047 to $2,294.

(5)

Net loss for the second quarter of fiscal 2009 includes a loss on a natural gas contract of $5,447, loss on impairment of assets of $8,931, severance and early retirement costs of $3,288 and other restructuring costs of $5,241.

(6)

Net loss for the third quarter of fiscal 2009 includes a loss on a natural gas contract of $2,106.

(7)

Net loss for the fourth quarter of fiscal 2009 includes a loss on a natural gas contract of $89 and a loss on impairment of assets of $1,351.

(8)

Earnings (loss) per share per quarter does not sum to total earnings (loss) per share due to rounding.

 

LIQUIDITY AND CAPITAL RESOURCES

 

Our principal uses of cash are for the cost of raw materials and energy used in our production processes, salaries, debt service obligations on our borrowings and capital expenditures.  Our principal sources of cash are revenues from the products we make and our revolving credit facility.

 

On August 25, 2009, we were required to make a deposit of approximately $1,600 to our surety bond carrier.  This deposit secured our obligations under surety bonds maintained to meet regulatory requirements for distillery operations.  Funds for this deposit were borrowed under the terms of the Credit Agreement.  Also in August, we received $325 as a deposit refund from a vendor.

 

As a result of losses incurred during fiscal years 2009, we received a tax refund of approximately $5,500 during October 2009, which was applied to our $11,614 note to CILCO.  During January 2010 we

 

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received an additional tax refund of approximately $4,700 resulting from changes in tax laws that enabled us to carry back losses to periods previously unavailable. For further information, see Note 5 Income Taxes set forth in Item 8.

 

As noted elsewhere herein, we have taken steps to focus our business on the production of value-added products, which have improved our operating performance.  As a result of the measures that we have taken combined with lower grain costs, operating costs have been reduced and cash flows from operating activities have increased.

 

We made significant improvements to our liquidity and capital resources during fiscal 2010.  We reduced our debt by $27,841 from $30,612 at June 30, 2009 to $2,771 at June 30, 2010.  We increased our cash position by $6,191 to $6,369 at June 30, 2010 from $178 at June 30, 2009.  We also have increased the amount available under our line of credit to $20,174 at June 30, 2010 from $4,190 at June 30, 2009.

 

We expect our sources of cash to be adequate to provide for our needs in fiscal 2011.

 

The following table is presented as a measure of our liquidity and financial condition as of June 30, 2010 and 2009:

 

 

 

2010

 

2009

 

Cash and cash equivalents

 

$

6,369

 

$

178

 

Working capital

 

25,142

 

31,242

 

Amounts available under lines of credit

 

20,174

 

4,190

 

Credit facility, notes payable and long-term debt

 

2,771

 

33,337

 

Stockholders’ equity

 

72,784

 

63,884

 

 

Certain components of our liquidity and financial results for the years ended June 30, 2010 and June 30, 2009 were as follows:

 

 

 

2010

 

2009

 

 

 

 

 

 

 

Depreciation and amortization

 

$

8,631

 

$

11,946

 

Capital expenditures

 

2,062

 

2,069

 

Cash flows from operations

 

32,667

 

3,158

 

 

CASH FLOW INFORMATION

 

Summary cash flow information follows for the years ended June 30, 2010 and June 30, 2009, respectively:

 

 

 

2010

 

2009

 

Cash flows provided by (used in):

 

 

 

 

 

Operating activities

 

$

32,667

 

$

3,158

 

Investing activities

 

16,043

 

(1,325

)

Financing activities

 

(42,519

)

(1,655

)

Increase in cash and cash equivalents

 

6,191

 

178

 

Cash and cash equivalents at beginning of year

 

178

 

 

Cash and cash equivalents at end of year

 

$

6,369

 

$

178

 

 

During the year ended June 30, 2010, our consolidated cash increased $6,191 compared to an increase of $178 during the year ended June 30, 2009.  Operating cash flow improved over the year ended June 30, 2009 primarily as a result of a $77,861 increase in earnings from a $69,123 net loss for the year ended June 30, 2009 to net income of $8,738 for the year ended June 30, 2010.  This increase was offset by smaller reductions in accounts receivable and inventory for the year ended June 30, 2010 compared to the year ended June 30, 2009.  Investing cash flows improved over the year ended June 30, 2009 primarily

 

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related to the sale of 50 percent of the membership interest in ICP.   Payments on our long-term debt and our line of credit resulted in a use of cash.

 

Operating Cash Flows.  Summary operating cash flow information for the years ended June 30, 2010 and June 30, 2009, respectively, is as follows:

 

 

 

2010

 

2009

 

Net income (loss)

 

$

8,738

 

$

(69,123

)

Depreciation and amortization

 

8,631

 

11,946

 

Gain on sale of assets

 

(1,731

)

(285

)

Share based compensation

 

491

 

14

 

Loss on joint venture formation

 

2,294

 

 

Loss on impairment of assets

 

 

10,282

 

Deferred income taxes

 

 

(7,217

)

Equity in loss of joint ventures

 

2,173

 

114

 

Changes in working capital items:

 

 

 

 

 

Restricted cash

 

(768

)

(200

)

Receivables

 

729

 

15,684

 

Inventory

 

2,766

 

42,456

 

Prepaid expenses

 

(537

)

(1,130

)

Accounts payable

 

1,439

 

(3,063

)

Accounts payable to affiliate, net

 

4,951

 

 

Accrued expenses

 

1,871

 

(694

)

Deferred credit

 

(811

)

(846

)

Income taxes payable/receivable

 

5,467

 

2,525

 

Accrued retirement health and life insurance benefits and other noncurrent liabilities

 

(3,277

)

4,968

 

Gains previously deferred in other comprehensive income

 

 

(2,149

)

Other

 

241

 

(124

)

 

 

 

 

 

 

Net cash provided by operating activities

 

$

32,667

 

$

3,158

 

 

Cash flow from operations for the year ended June 30, 2010 increased $29,509 to $32,667 from $3,158 for the year ended June 30, 2009.  This increase in operating cash flow was primarily the result of a $77,861 increase in earnings, from a $69,123 net loss for the year ended June 30, 2009 to net income of $8,738 for the year ended June 30, 2010.  Deferred income taxes had a $0 non-cash impact on net income for the year ended June 30, 2010 compared to a $7,217 non-cash reduction to net loss for the year ended June 30, 2009.  Other factors resulting in an increase in operating cash flows was a $12,018 combined increase in accounts payables, accounts payable to affiliate, net and accrued expenses to $8,261 for the year ended June 30, 2010 compared to ($3,757) for the year ended June 30, 2009.  The increase in accounts payable resulted from our return to normal credit terms with suppliers as a result of our improved financial condition.  The increase in accounts payable to affiliate, net results from our operations with ICP. The increase in accrued expenses is primarily the result of an increase in accrued bonuses.

 

These factors, which served to improve operating cash flow, were partially offset by the following:

 

·                  For the year ended June 30, 2010, inventory reductions generated positive operating cash flow of $2,766 compared to $42,456 for the year ended June 30, 2009 when we reduced a significant inventory buildup from the prior year;

·                  For the year ended June 30, 2010, accounts receivable declined relatively less, generating positive operating flow of $729 compared to $15,684 for the year ended June 30, 2009;

·                  For the year ended June 30, 2010, accrued retiree benefits and other non-current liabilities

 

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decreased, resulting in a use of cash of $3,277 compared to the year ended June 30, 2009, which generated positive operating cash flow of $4,968; and

·                  An adjustment to net loss for the year ended June 30, 2009 for a non-cash impairment charge of $10,282.

 

Investing Cash Flows.  Net investing cash flow for the year ended June 30, 2010 was $16,043 compared to a cash outflow of $1,325 for the year ended June 30, 2009 for a net increase of $17,368 in investing cash flows.  For the year ended June 30, 2010, we received net proceeds of $13,951 related to the sale of a 50 percent membership interest in ICP.  Proceeds from the disposition of property and equipment for the year ended June 30, 2010 increased $4,623 to $5,367 from $744 for the year ended June 30, 2009.    These increases were partially offset by a $1,213 investment in and advances to unconsolidated subsidiaries for the year ended June 30, 2010.

 

Financing Cash Flows.  Net financing cash outflow for the year ended June 30, 2010 was $42,519 compared to net financing cash outflow of $1,655 for the year ended June 30, 2009 for a net increase in cash outflow of $40,864.  This increase in cash outflow was the result of the following:

 

·                        Net payments on the line of credit of $18,138 for the year ended June 30, 2010, compared to net payments of $5,167 for the year ended June 30, 2009.

·                        Proceeds from long-term debt for the year ended June 30, 2010 decreased $5,318 to $2,032 from $7,350 for the year ended June 30, 2009.

·                        Principal payments on long-term debt for the year ended June 30, 2010 increased $22,603 to $26,379 from $3,776 for the year ended June 30, 2009.

 

CAPITAL EXPENDITURES

 

For the year ended June 30, 2010, we incurred $2,062 in capital expenditures, primarily related to production and capacity upgrades.  For the year ended June 30, 2009, we incurred $2,069 in capital expenditures, primarily related to production and capacity upgrades.  We also made improvements to our information technology property and data center in both years.

 

For fiscal 2011, we have budgeted $4,500 in routine capital expenditures related to improvements in and replacements of existing plant and equipment and information technology.  In addition, we have begun work on a major capital project designed to provide environmental benefits at our Atchison, Kansas distillery while also enhancing alcohol production capabilities.  The product will involve the installation of a new, state of the art water cooling system to replace older equipment used to supply water for multiple components of the distillation process.  It is expected to be completed by the end of September 2011 at an estimated cost of $8,500.  As of June 30, 2010, we had contracts to acquire capital assets of approximately $578.

 

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CONTRACTUAL OBLIGATIONS

 

Our contractual obligations at June 30, 2010 are as follows:

 

 

 

Fiscal Year

 

 

 

2011

 

2012

 

2013

 

2014

 

2015

 

Thereafter

 

Total

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Long term debt (1)

 

$

256

 

$

276

 

$

298

 

$

322

 

$

347

 

$

284

 

$

1,783

 

Capital leases (2)

 

433

 

269

 

217

 

69

 

 

 

988

 

Operating leases

 

2,422

 

2,010

 

1,608

 

981

 

861

 

1,213

 

9,095

 

Post-retirement benefits

 

782

 

789

 

734

 

642

 

580

 

3,541

 

7,068

 

Defined benefit retirement plan

 

115

 

186

 

172

 

250

 

285

 

1,506

 

2,514

 

Open purchase commitments (3)

 

1,587

 

 

 

 

 

 

1,587

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total

 

$

5,595

 

$

3,530

 

$

3,029

 

$

2,264

 

$

2,073

 

$

6,544

 

$

23,035

 

 


(1)         Long term debt at June 30, 2010 included the following:

 

(a)         Union State Bank — Bank of Atchison promissory note dated July 20, 2009 in the initial principal amount of $2,000 secured by a mortgage and security interest on our Atchison plant and related equipment.  The note bears interest at 6 percent over the three year treasury index, adjustable quarterly, and is payable in 84 monthly installments of $32, with any balance due on the final installment.  At June 30, 2010, $1,783 was outstanding under the note.

 

(b)         On July 21, 2009, we entered a new revolving Credit and Security Agreement with Wells Fargo Bank, National Association.  The Credit and Security Agreement has been amended by consents dated August 19, 2009, December 21, 2009, December 31, 2009 and February 2, 2010 and by a First Amendment (“First Amendment”) dated June 30, 2010 (as so amended, the “Credit Agreement”).  The Credit Agreement, which matures in July 2012, generally provides for a Maximum Line of Credit of $25,000, subject to borrowing base limitations. At June 30, 2010, there were no borrowings outstanding under the Credit Agreement.  Borrowings under the Credit Agreement bear interest, payable monthly, at a variable rate equal to Daily Three Month LIBOR plus 5 percent, but not less than 5.5 percent. During a default period, the interest rate may be increased by 3 percent at the lender’s discretion. The Credit Agreement provides for minimum interest of $500 annually, an unused line fee of .50 percent per annum and origination fees, letter of credit fees and other administrative fees.  If we terminate the facility prior to the maturity date or the lender terminates during a default period, there is a prepayment fee of 3 percent if the termination occurs prior to the first anniversary date, declining to 1 percent if the termination occurs after the second anniversary of the initial funding. The Credit Agreement is secured by a security interest in substantially all of our personal property and by mortgages or leasehold mortgages on our facilities in Atchison and Onaga.  The lender may terminate or accelerate our obligations under the Credit Agreement upon the occurrence of various events in addition to payment defaults and other breaches, including such matters as over advances arising from reductions in the borrowing base, certain changes in the Board, failure to pay taxes when due, defaults under other material debt, lease or other contracts and our CEO ceasing to be actively engaged in the Company’s day to day business activities and the Company shall fail to hire a successor acceptable to the lender in 90 days.

 

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Pursuant to the First Amendment, among other matters Well Fargo agreed to amend the Credit Agreement, such that:

 

·                  We could exclude from a $4,500 annual capital expenditure limitation the capital expenditures made for the replacement and/or upgrade of our existing water cooling facility; and

 

·                  We could defer minimum interest otherwise payable under the Credit Agreement from the loan year ending in July 2010 to the loan year ending in July 2011.  As a result, the minimum interest provision for the loan year ending in July 2011 will be approximately $650 instead of $500.

 

(2)         In connection with improvements made to the Company’s data center, $1,200 in costs incurred during development of the system have been funded by Winthrop Resources Corporation and CSI Leasing, Inc. under various capital lease agreements with rates ranging from 4.56 percent to 5.54 percent.  These agreements, which are unsecured, have maturities ranging from July, 2010 to October, 2013.

 

Additionally, we financed $71 in equipment purchases through a capital lease with Delage Corporation at 7.15 percent.  This capital lease is secured by the equipment purchased and matures in October, 2011.

 

(3)         Purchase Commitments at June 30, 2010 included the following

 

(a)         Commitments ($846) to purchase corn to be used in our operations during the first 4 weeks of fiscal 2011.

 

(b)         Commitment ($163) to purchase natural gas during the first 11 months of fiscal 2011.

 

(c)          Commitments ($578) related to capital expenditures, of which $308 relates to the water cooling project.

 

LINE OF CREDIT

 

Reference is made to Note 4 Corporate Borrowings and Lease Obligations and above for information on our Credit Agreement. The amount of borrowings which we may make is subject to borrowing base limitations.  As of August 31, 2010, our outstanding borrowings under this facility were $0 and $20,174 was available for additional borrowings.  The borrowing base is the lesser of the maximum line amount or an amount based on specified percentages of eligible accounts receivable and inventories less specified reserves.  The lender has discretion under the Credit Agreement to change the manner in which the borrowing base is determined, such as altering the advance rates applicable to accounts receivable and inventory or changing reserve amounts.

 

FINANCIAL COVENANTS

 

Under the Credit Agreement, we must meet specified monthly, cumulative net income requirements (aggregating $3,500 for fiscal year 2010 and $1,000 for the first quarter of fiscal 2011), are limited in the amount of capital expenditures we may make annually ($4,500) (excluding capital expenditures made for the replacement and or upgrade of the Company’s existing water cooling facility), and must meet as of fiscal year end, a minimum debt service coverage ratio ( (a) the sum of (i) funds from operations (net income plus depreciation and amortization, plus or minus increases or decreases in deferred income taxes and LIFO reserves, plus other non-cash items) plus (ii) interest expense minus (iii) unfinanced capital expenditures minus (iv) dividends and distributions paid during the period, divided by (b) the sum of  (i) current maturities of long term debt plus (ii) interest expense) of not less than 1.15 to 1.0.

 

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The lender has significant lending discretion under the Credit Agreement; it may modify our borrowing base and various components thereof in its reasonable discretion, thereby affecting the amount of credit available to us. The lender may terminate or accelerate our obligations under the Credit Agreement upon the occurrence of various events in addition to payment defaults and other breaches, including such matters as over advances arising from reductions in the borrowing base, certain changes in the Board, failure to pay taxes when due, defaults under other material debt, lease or other contracts and our CEO ceasing to be actively engaged in our day to day business activities if we fail to hire a successor acceptable to the lender within 90 days. We have maintained compliance with these covenants through June 30, 2010.

 

The Credit Agreement also includes provisions that limit or restrict our ability to:

 

·            incur additional indebtedness;

·            pay dividends to stockholders or purchase stock;

·            make investments;

·            dispose of assets;

·            make capital expenditures;

·            create liens on our assets; or merge or consolidate.

 

The net income requirements imposed under the Credit Agreement for fiscal 2010 and the first fiscal quarter of 2011 are set forth below.  Upon expiration of this covenant we will be required to amend it to cover future periods upon terms acceptable to our lender.  Targets subsequent to September 30, 2010 have not been set as of August 31, 2010.

 

Period

 

Minimum Cumulative Net
Income from July 1, 2009

 

7/1/2009 Through 7/31/2009

 

$

200

 

7/1/2009 Through 8/31/2009

 

$

700

 

7/1/2009 Through 9/30/2009

 

$

1,000

 

7/1/2009 Through 10/31/2009

 

$

1,250

 

7/1/2009 Through 11/30/2009

 

$

1,350

 

7/1/2009 Through 12/31/2009

 

$

1,500

 

7/1/2009 Through 1/31/2010

 

$

1,800

 

7/1/2009 Through 2/28/2010

 

$

2,200

 

7/1/2009 Through 3/31/2010

 

$

2,575

 

7/1/2009 Through 4/30/2010

 

$

3,000

 

7/1/2009 Through 5/31/2010

 

$

3,250

 

7/1/2009 Through 6/30/2010

 

$

3,500

 

7/1/2010 Through 7/31/2010

 

$

200

 

7/1/2010 Through 8/31/2010

 

$

700

 

7/1/2010 Through 9/30/2010

 

$

1,000

 

 

The Credit Agreement contains various other covenants, including covenants which generally restrict dividends and increases in certain bonuses and salaries and prohibit liens, other than permitted liens, indebtedness, except existing indebtedness and indebtedness to the lender, and investments in other persons.

 

Loan covenants in ICP’s loan agreements with its lenders restrict it from paying dividends to us except for distributions to pay taxes on our share of ICP income allocable to us.

 

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OFF BALANCE SHEET OBLIGATIONS

 

Arrangement with Cargill.  We have entered a business alliance with Cargill, Incorporated for the production and marketing of a new resistant starch derived from high amylose corn. We have sold only an insignificant amount of the product, and the agreement with Cargill does not appear to be significant at this time.  If we terminate the arrangement before the expiration of 18 months following certain force majeure events affecting Cargill, or if Cargill terminates the arrangement because of a breach by us of our obligations, we will be required to pay a portion (up to 50 percent) of the book value of capital expenditures made by Cargill to enable it to produce the product. This amount will not exceed $2,500 without our consent. Upon the occurrence of any such event, we also will be required to give Cargill a non-exclusive sublicense to use the patented process for the life of the patent in the production of high amylose corn-based starches for use in food products. The sublicense would be royalty bearing, provided we were not also then making the high amylose corn-based starch.

 

Corn Supply Contract.  We purchase our corn requirements through a single elevator company.  If we fail to purchase at least 13 million bushels each 12 months, we must pay the elevator company $0.03 per bushel for each bushel less than 13 million purchased.  The elevator company may terminate if we fail to purchase the specified minimums, in which case we would be obligated to pay the elevator company $260 plus the costs incurred by the elevator company in contracting with a different customer for the delivery of corn purchased for us pursuant to our previously issued delivery orders.  Our practice has been to only order corn for a month at a time.  We are on pace to exceed the minimum requirement.

 

Industrial Revenue Bond.  On December 28, 2006, we engaged in an industrial revenue bond transaction with the City of Atchison, Kansas in order to receive ten-year real property tax abatement on our newly constructed office building and technical center in Atchison, Kansas. At the time of this transaction, the facilities were substantially completed and had been financed with internally generated cash flow.  We recorded the office building and technical center assets into property and equipment on the consolidated balance sheets.  Pursuant to this transaction, the City issued $7,000 principal amount of its industrial revenue bonds to us and then used the proceeds to purchase the office building and technical center from us.  The City then leased the facilities back to us under a capital lease, the terms of which provide for the payment of basic rent in an amount sufficient to pay principal and interest on the bonds.  Our obligation to pay rent under the lease is in the same amount and due on the same date as the City’s obligation to pay debt service on the bonds which we hold. The lease permits us to present the bonds at any time for cancellation, upon which our obligation to pay basic rent would be cancelled.  We do not intend to do this until their maturity date in 2016, at which time we may elect to purchase the facilities for $100.  Because we own all outstanding bonds, management considers the debt de-facto cancelled and, accordingly, no amount for our obligations under the capital lease is reflected on our balance sheet.  In connection with this transaction, we agreed to pay the city an administrative fee of $50, which is payable over 10 years.  If we were to present the bonds for cancellation prior to maturity, the $50 fee would be accelerated.

 

Indemnification Arrangement with ICP and ICP Holdings.  Our Contribution Agreement with ICP and the LLC Interest Purchase Agreement with ICP Holdings require us to indemnify ICP and ICP Holdings from and against any damages or liabilities arising from a breach of our  representations and warranties in the Contribution Agreement and the LLC Interest Purchase Agreement  and also with respect to certain environmental damages or liabilities related to the recommencement of production at the Pekin plant or to operations at the Pekin plant prior to the closing of the LLC Interest Purchase Agreement.  The amount of damages, with the exception of taxes and environmental matters, is limited to a maximum of $30,000.

 

ICP Steam Facility.  On January 29, 2010, ICP acquired for $5,000  the existing steam facility that services the Pekin plant.  The Company and ICP Holdings each contributed $1,000 and will equally fund the balance of the purchase price over the next two years.

 

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NEW ACCOUNTING PRONOUNCEMENTS

 

For information with respect to recent accounting pronouncements and the impact of these pronouncements on our consolidated financial statements, see Note 18 Recently Issued Accounting Pronouncements set forth in Item 8.

 

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ITEM 7A.  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

 

We make our products primarily from flour and corn and, as such, are sensitive to changes in commodity prices.  We use grain futures and/or options, which mark to market, as a hedge to protect margins on contracted alcohol sales.   Fluctuations in the volume of hedging transactions are dictated by alcohol sales and are based on corn, natural gas and gasoline prices.  The futures contracts that are used are exchange-traded contracts.  We trade on the Kansas City and Chicago Boards of Trade and the New York Mercantile Board of Exchange.  Historically, we have included the fair values of open contracts in inventories.

 

For inventory and open futures, the table below presents the carrying amount and fair value at June 30, 2010 and 2009.  All amounts below are in thousands, except for strike price per bushel.  We include the fair values of open contracts in inventories in our balance sheets.

 

 

 

At June 30, 2010

 

At June 30, 2009

 

As of June 30,

 

Carrying
Amount

 

Fair Value

 

Carrying
Amount

 

Fair Value

 

Inventories

 

 

 

 

 

 

 

 

 

Corn

 

$

1,611

 

$

1,654

 

$

1,108

 

$

1,030

 

Flour

 

$

132

 

$

130

 

$

108

 

$

109

 

 

 

 

Description and
Expected
Maturity*

 

Fair Value

 

Description and
Expected
Maturity*

 

Fair Value

 

 

 

 

 

 

 

 

 

 

 

Corn Options

 

$

 

$

 

$

 

$

 

Contract Volumes (bushels)

 

875

 

 

 

 

 

 

 

Weighted Average

 

 

 

 

 

 

 

 

 

Strike Price/Bushel

 

$

 

$

 

$

 

$

 

Long Calls

 

$

 

$

 

$

 

$

 

Short Calls

 

$

 

$

 

$

 

$

 

Short Puts

 

$

0.17

 

$

0.15

 

$

 

$

 

Contract Amount

 

$

149

 

$

135

 

$

 

$

 

 

 

 

Description and
Expected
Maturity*

 

Fair Value

 

Description and
Expected
Maturity*

 

Fair Value

 

 

 

 

 

 

 

 

 

 

 

Corn Futures

 

$

 

$

 

$

 

$

 

Contract Volumes (bushels)

 

1,500

 

 

 

670

 

 

 

Weighted Average

 

 

 

 

 

 

 

 

 

Strike Price/Bushel

 

$

3.53

 

$

3.54

 

$

3.94

 

$

3.54

 

Contract Amount

 

$

5,299

 

$

5,310

 

$

2,643

 

$

2,375

 

 


*The latest expected maturity date occurs within one year from balance sheet date.

 

Our loan from Union State Bank — Bank of Atchison bears interest at 6% over the three year treasury index, adjusted quarterly.  Our Credit Agreement with Wells Fargo Bank provides for interest at a variable rate equal to daily three month LIBOR plus 5%, but not less than 5.5%;  the default rate is 3% higher, in the lender’s discretion.  Increases in market interest rates would cause interest expense to increase and earnings before income taxes to decrease. The change in interest expense and earnings before income taxes would be dependent upon the weighted average outstanding borrowings during the reporting period following an increase in market interest rates. Based on weighted average outstanding borrowings at August 31, 2010, a 100 basis point increase over the non-default rates actually in effect at such date would increase our interest expense on an annualized basis by $18.

 

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ITEM 8.  FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

 

MANAGEMENT’S REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING

 

The management of MGP Ingredients, Inc. is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Exchange Act Rules 13a-15(f).  Internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles.  Internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of our assets; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that our receipts and expenditures are being made only in accordance with authorizations of our management and directors; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of our assets that could have a material effect on the financial statements.

 

Because of its inherent limitations, our internal control over financial reporting may not prevent or detect misstatements.  A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met.  Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, have been detected.  Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies and procedures may deteriorate.

 

With the participation of the Chief Executive Officer and the Chief Financial Officer, our management conducted an evaluation of the effectiveness of our internal control over financial reporting based on the framework and criteria established in “Internal Control - Integrated Framework” issued by the Committee of Sponsoring Organizations of the Treadway Commission. As a result of this assessment, management has concluded that the company’s internal control over financial reporting as of June 30, 2010 was effective.

 

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

 

The Board of Directors and Stockholders
MGP Ingredients, Inc.:

 

We have audited the accompanying consolidated balance sheets of MGP Ingredients, Inc. and subsidiaries as of June 30, 2010 and 2009, and the related consolidated statements of operations, changes in stockholders’ equity and comprehensive income (loss), and cash flows for the years in the two-year period ended June 30, 2010. In connection with our audits of the consolidated financial statements, we also have audited the accompanying financial statement schedule, Schedule II — Consolidated Valuation and Qualifying Accounts for each of the fiscal years in the two-year period ended June 30, 2010.  We also have audited MGP Ingredient Inc.’s internal control over financial reporting as of June 30, 2010, based on Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).  MGP Ingredients, Inc.’s management is responsible for these consolidated financial statements and financial statement schedule, for maintaining effective internal control over financial reporting, and for its assertion of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Report on Internal Controls over Financial Reporting.  Our responsibility is to express an opinion on these consolidated financial statements and financial statement schedule, and an opinion on MGP Ingredients Inc.’s internal control over financial reporting based on our audits.

 

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We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States).  Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audit of the consolidated financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation.  Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk.  Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.

 

A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with accounting principles generally accepted in the United States of America. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with accounting principles generally accepted in the United States of America, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention, or timely detection  of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

 

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements.  Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

 

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of MGP Ingredients, Inc. and subsidiaries as of June 30, 2010 and 2009, and the results of its operations and its cash flows for each of years in the two-year period ended June 30, 2010, in conformity with accounting principles generally accepted in the United States of America.  Also, in our opinion, the accompanying financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, present fairly, in all material respects, the financial information set forth therein.  Also, in our opinion, MGP Ingredients, Inc. maintained, in all material respects, effective internal control over financial reporting as of June 30, 2010, based on criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission.

 

/s/ KPMG LLP

 

Kansas City, Missouri

September 2, 2010

 

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MGP INGREDIENTS, INC.

 

CONSOLIDATED STATEMENTS OF OPERATIONS

Fiscal Years Ended

 

 

 

June 30, 2010

 

June 30, 2009

 

 

 

(Dollars in thousands, except per share
amounts)

 

 

 

 

 

 

 

Net sales

 

$

201,971

 

$

291,812

 

Cost of sales

 

171,427

 

325,914

 

Gross profit (loss)

 

30,544

 

(34,102

)

 

 

 

 

 

 

Selling, general and administrative expenses

 

20,708

 

21,401

 

Other operating costs

 

2,018

 

4,694

 

Impairment of long-lived assets

 

 

10,282

 

Severance and early retirement costs

 

 

3,288

 

Loss on joint venture formation

 

2,294

 

 

Gain on sale of assets

 

(1,731

)

 

Other restructuring costs

 

 

5,241

 

Income (loss) from operations

 

7,255

 

(79,008

)

 

 

 

 

 

 

Other income, net

 

645

 

112

 

Interest expense

 

(1,757

)

(2,901

)

Equity in loss of joint ventures

 

(2,173

)

(114

)