February 12,
2008
H. Roger Schwall
Assistant Director
Securities and Exchange
Commission
Washington, DC 20549-0405
Re: MGP Ingredients, Inc.
Dear Mr. Schwall:
This is in response to
your letter of January 31, 2008 in respect to our annual report on Form 10-K
for the fiscal year ended July 1, 2007 and our quarterly report on Form 10-Q
for the quarter ended September 30, 2007.
We are keying our responses to your comments, which we have
underlined. We hope this letter
adequately addresses your questions.
Form 10-K for the year ended
July 1, 2007
General
1. Please confirm in writing that you will
comply with the following comments in all future filings. Provide us also with an example of the
disclosure you intend to use. Please understand
that after our review of your responses, we may raise additional comments.
We
confirm that we will comply with the following comments in future filings and
have provided, where appropriate, an example of the disclosure that we intend
to use.
2. You state that on July 2, 2007, you
acquired a 50% interest in a German joint venture company which will produce
and distribute your Wheatex® products in the European Union (EU) and
elsewhere. Please provide us with an
analysis as to whether you were required to file a Form 8-K with respect
to this acquisition, and whether you are required to file the agreement
relating to this acquisition.
We advise the staff that
at the time we entered the joint venture, we considered whether we were
required to file an 8-K and concluded that we were not.
The joint venture in
question relates to the manufacture and distribution of our Wheatex
products. During our most recent fiscal
year ended July 1, 2007 (fiscal 2007), total sales of our Wheatex products
were less than $5.0 million, which represented less than 2% of our total sales
and 6% of our ingredients sales. To date
we have had no sales of product through the activities of the joint
venture. Our anticipated sales of
product for each of the first two years of the joint venture represent less
than 3% of our total sales in fiscal 2007. Only a portion of our anticipated
sales through the joint venture will be incremental, as we have been
distributing this product through an affiliate of our joint venture partner
since 2003.
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Our total capital
commitment to date with respect to this project is $750,000, of which we have
contributed $358,000 thus far.
We do not regard the
joint venture as a significant acquisition under Item 2.01 because our equity
in the net book value of the joint venture is less than 10% of our assets and
the joint venture does not meet any of the tests for a significant business
under Reg. S-X 11.01(b). Nor, in light
of the factors mentioned above, do we regard the contractual arrangements with
our joint venture partner as material under Item 1.01 of Form 8-K.
We also consider these
arrangements as ordinary course. The
nature of our business is such that we sometimes outsource production through
various types of arrangements in order to gain access to markets or supplement
our production facilities. These
typically, although not always, involve processes which are patented or involve
trade secrets. For example, we have entered into a series of production,
licensing and distribution arrangements relating to a high amylose starch
product with one company and a production agreement with another company
relating to a potato starch product. Both arrangements involved one of our
patented processes. Similarly, our arrangements
with the joint venture involve a license of our trade secrets. We have also used toll processors to make
product for us.
3. You disclose in the table on page 36
open purchase commitments to purchase grain and natural gas during the first 12
weeks of fiscal 2008 totaling $30.978 million.
Please tell us whether these will have a material impact on your
liquidity, and if so, tell us the impact.
We advise the staff that
grains are our principal raw materials and natural gas is our principal energy
source for all of our manufacturing processes,
the costs for which are incurred within
the normal course of our business. The
$30.978 million commitment at July 1, 2007 related to grain and natural
gas represented approximately 62% of the raw material cost for the subsequent
quarter ended September 30, 2007.
All but $4.0 million of our total production costs for the quarter were financed
by operating cash flow, and the $4.0 was financed by draws on our line of
credit. We did not view this commitment
as having had a material impact on our liquidity.
Capital Expenditures, page 36
4. We note you are exploring alternative
sources of energy for your Pekin, Illinois plant in the form of a coal-fired
steam generation facility. We also note on page 12 that you have a
long-term arrangements with AmerenCILCO at your Pekin, Illinois plant with
payment contingencies for non-renewal of the arrangement. Please expand your disclosure to quantify
what potential impact settling the long-term arrangement could have on
liquidity if you went forward with building your own coal-fired steam
generation facility.
We advise the staff as
follows:
We currently have a steam
heat service agreement, subject to limited termination procedures, to purchase
our requirements for steam heat from CILCO until at least
February 2011. This agreement
contains certain stipulations for minimum payments in the event we choose to
terminate it. We currently estimate that
it would take three to four years for the facility to be operational after we
make a decision to proceed. We
anticipate being able to adequately coordinate construction and start up of
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our new facility to
enable us to give the required two years notice of non-renewal, and thus
anticipate no impact on liquidity related to any termination payments.
Additionally, under a
separate agreement with CILCO, we have leased a portion of our Pekin, Illinois
plant facility to CILCO for a term ending in February 2010. CILCO
constructed a new gas fired electric and steam generating facility on ground
leased from us and agreed to provide steam heat to our plant. If we fail to
renew the lease for 19 years at the end of the lease term, we must pay CILCO
the book value of the boiler plant and cogeneration facility, which we estimate
will be $10.6 million. We are currently
negotiating with CILCO to purchase this facility for market value, which we
believe is less than $10.6 million. If
we are unable to satisfactorily reach an agreement with CILCO, we will renew
the lease for the additional 19 years.
Neither the cost of the
facility nor the cost of a replacement facility that we would require as part
of our new boiler project is reflected in the preliminary estimate of $65
million that we indicated as the possible cost of the facility. We will
update our estimate in future filings as projected costs become more clear or
change, and, as appropriate, indicate whether or not costs associated with
acquiring or replacing the existing facility are included in our estimate.
Currently we are
seeking an outside 3rd party to entirely construct, own and operate the coal
boiler steam generation facility and provide steam to our Pekin, Illinois plant
with no investment by MGP. Should we be
required to make an investment, we hope to limit our equity investment to $6
million with the balance of the construction costs being supplied by the third
party and non-recourse debt to the joint venture entity.
Consolidated Statements
of Cash Flows, page 47
5. We note you have segregated certain cash
and investment accounts in accordance with your commodity exchange
requirements. Your disclosure on page 49
indicates that your segregated accounts have been pledged to your broker for
exchange-traded commodity instruments.
As these cash balances have been pledged, please clarify why you have
not categorized these cash balances as restricted pursuant to Rule 5-02.1
of Regulation S-X. In addition, please
provide your basis for reporting cash flows from your segregated cash and
investments as an operating activity, as opposed to an investing activity.
We will re-title the cash
balances as “restricted cash” pursuant to Rule 5-02.1 of Regulation S-X in
future filings (including our Quarterly Report on Form 10-Q for the period
ended December 30, 2007). Because these balances
represent cash only that is restricted pursuant to an agreement with our broker
for exchange-traded commodity instruments used to hedge operating costs, we
have classified changes in the restricted cash balance as an
operating activity instead of an investing activity.
Note 1: Nature of Operations and summary of
Significant Accounting Policies
Derivative Instruments, page 50
6. Your disclosure states that you defer
gains and losses from your cash flow hedges in other comprehensive income until
the finished goods related to the hedged transaction are sold. We also note your disclosure of the
expiration dates of your various cash flow hedges on page 67, which are as
early as September 2007. Therefore,
it appears there may be differences in the dates that your derivatives expire
and the date that the related finished goods are sold. If this is the case, please explain how you
apply paragraphs 31 through 35 of SFAS 133 when determining the appropriate period
to recognize the net gain or loss from the hedging activity. Please clarify whether you had any situations
where the forecasted transaction did not occur by the end of the originally
specified time period as of July 1, 2007.
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We advise the staff that
at the time we enter into derivative instruments for the purpose of hedging the
cost of inputs, we specifically identify and assign the raw material hedged to
be the first quantity of such raw material purchased and consumed within the
production process for the month and document accordingly at inception. An analysis of alcohol inventory as of December 31,
2006 (the most recent published financial statements prior to entrance into the
September contracts referred to above) and again at year-end indicates 16
and 12 days in inventory, respectively.
Additionally, an analysis of corn inventory (the hedged raw material) as
of December 31, 2006 and again at year-end indicates 7 and 8 days in
inventory, respectively, for a total combined days in inventory from purchase
of raw material to the sale of the finished product of 25 and 20 days,
respectively. Accordingly, we conclude that, applying SFAS 133 paragraph 31, we
are properly reclassifying into earnings
amounts in accumulated other comprehensive income in the same period during
which the hedged forecasted transaction (sale of the alcohol produced) affects
earnings. We did not have any situations where the forecasted transaction did
not occur by the end of the originally specified time period as of July 1,
2007.
Revenue Recognition, page 51
7. Your disclosure states, in part, that
revenue is recognized upon transfer of title.
Clarify whether title transfers when the product has been delivered or
shipped. Ensure your disclosure properly
addresses all contractual terms and conditions that might impact your revenue
recognition policy. We refer to revenue
disclosure guidance outlined in Section F (3) of the Current
Accounting and Disclosure Issues in the Division of Corporation Finance
published November 30, 2006.
We will revise our
revenue recognition disclosure as follows in future filings.
“Revenue from the sale of
the Company’s products is recognized as products are delivered to customers and
title has transferred. The place of
delivery and transfer of title depends on our shipping terms; in some cases our
contracts are FOB shipping point and in other FOB destination.
8. Tell us your consideration of disclosing
the material items of deferred income pursuant to Rule 5.02.26 of
Regulation S-X. Please ensure your
disclosure clarifies the nature of your deferred revenue.
We advise the staff that
deferred revenue of $7.9 million, as disclosed within the balance sheet as of July 1,
2007, reflects the balance remaining to be earned related to the USDA grant
discussed in Note 14 to the Financial Statements. Accordingly, we will revise our Note 1
disclosure and incorporate the Note 14 disclosure in future filings to read as
follows, when appropriate:
“Deferred
USDA Grant Revenue. During the fourth quarter of fiscal 2001, the
United States Department of Agriculture developed a grant program for the
gluten industry in place of a two-year extension of a wheat gluten import quota
that took effect on June 1, 1998. Over the life of the program, which was
administered by the Commodity Credit Corporation (“CCC”) and which ended on
May 31, 2003, the Company was eligible to receive nearly $26 million of
the program total of $40 million. For the first year of the program,
approximately $17.3 million was allocated to the Company, with the remaining
$8.3 million allocated in July 2002. The funds were required to be used
for research, marketing, promotional and capital costs related to value-added
gluten and starch products. Funds allocated on the basis of current operating
costs were recognized in
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income as those costs
were incurred. Funds allocated based on capital expenditures are being
recognized in income as the capital projects are depreciated. As of [Balance Sheet Dates], deferred USDA
Grant Revenue was $ and
$ respectively.”
Note 3. Long-term Debt
4.90% Industrial Revenue
Bond Obligation, page 55
9. We note you consider the debt “de-facto
cancelled” in the industrial revenue bond transaction and accordingly, no
amount for the bond is reflected as outstanding on the balance sheet as of July 1,
2007. Please tell us more specifically
how you accounted for this transaction and cite the authoritative accounting
guidance you applied when determining the debt cancelled. As part of your response, clarify whether you
have recorded the office building and related capital lease obligation on your
consolidated balance sheet as of July 1, 2007.
We acquired 100% of the
bonds that were issued to finance our office building and technical center
facilities. By financing the facilities in this manner, we obtained ten years
property tax abatement on the facilities.
In accounting for this transaction, we applied the guidance of FASB
Interpretation No. 39 paragraph 5 as it defines the right of setoff. We noted that:
1) Amounts (our capital lease obligation and the related industrial
revenue bonds that we held) were clearly determinable.
2) Based upon our rights as the holder of 100% of all
bonds issued, we have the right and the ability to set off the amounts owed on
the capital lease with the amount receivable related to the bonds held.
3) As the transaction was entered into solely to
facilitate the property tax abatement process, it is our intention to set off
the receivable (bonds held) against the debt (capital lease).
4) Per language contained within the capital lease
agreement, we are provided legal setoff rights to the extent that we own our
own bonds — which we do entirely.
In deriving our
conclusion, we also considered the economic substance of the transaction, which
was entered into to obtain property tax relief and represents an amount owed by
us to ourselves. Neither the bonds as a
liability nor the office building and technical center as assets are recorded
within the accounts of the City of Atchison, Kansas, as the City has no
recourse against us. Only the trustee
has recourse acting on behalf of the bond holder, MGP, Ingredients, Inc. Accordingly, we concluded no liability
existed since no “present duty or responsibility to one or more other entities
that entails settlement by probable future transfer or use of assets at a
specified or determinable date” exists (Statement of Financial Accounting
Concepts No. 6, paragraph 36). Therefore, we concluded that to record the
investment in IRB bonds and the related capital lease obligation would
inappropriately overstate non-current assets, current liabilities and
non-current liabilities. The office building
and technical center have been recorded within property, plant and equipment as
accounts payable were recognized.
Note 10. Operating
Segments, page 66
10. We note the continuing operating losses
in your Ingredients segment, along with an increased balance of long-lived
assets in this segment. Please tell us
how you determined the long-lived assets of the Ingredients segment were
recoverable as of July 1, 2007 and subsequent interim periods. Specifically clarify how you applied
paragraphs 16 through 21 of SFAS 144 when estimating the future cash flows used
to test the recoverability.
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We advise the staff that
in March 2007 our management group began work to develop a comprehensive
corporate strategy for the following five fiscal years. This was undertaken in part as a response to
recent losses within the ingredients segment in order to identify the issues
driving the losses and to undertake corrective action to reverse this
trend. As a result, we have implemented
a strategy incorporating a renewed focus on the manufacture and sale of
higher-margin specialty proteins and starches.
In developing our strategy, we developed projections of operating income
and related cash flow for the ingredients segment in order to provide a
benchmark against which to measure our performance. These projections were based upon estimates
of product mix, unit sales, unit prices, input costs as well as overall market
trends. Data incorporated within these
projections was derived from both outside sources as well as internal sources,
including product and market knowledge derived over years of experience. Our projections indicated that, upon
implementation of the new strategy, beginning in fiscal 2008, operating income
and cash flow from operations for the ingredients segment would reverse and
become positive and remain such through the following years and that the trend
observed early in fiscal 2007 would only be temporary.
In June, 2007, our
management group re-assessed the strategy and related projections in light of
higher raw material costs. Although we
revised our projections downwards, we still projected positive operating income
and cash flow for the ingredients segment.
Furthermore, we noted that the trend towards losses within the
ingredients segment had reversed, as the ingredients segment reported income
before taxes of $607,000 for the fourth quarter of fiscal 2007 compared to net
losses before taxes of $1.9 million, $4.6 million and $3.6 million for the 3rd,
2nd and 1st quarters of fiscal 2007 respectively. We
incorporated this data into our impairment analysis in accordance with
paragraphs 16 through 21 for the ingredients segment asset group and further
for our pet products asset group and concluded that no asset impairment
adjustment was necessary.
As we consider the year
to date results for fiscal 2008 as of December 30, 2007, management notes
that our Ingredient Solutions segment is reporting pre-tax income of $187,000
compared to a pre-tax loss of $5.2 million for the year to date period ended December 31,
2006 (as adjusted to reflect the expansion of segments from two to three.) Our Other segment is reporting a loss of $4.1
million for the year to date period ended December 30, 2007 compared to a
loss of $3.7 million for the year to date period ended December 31,
2006. This segment consists primarily of
pet products and plant based biopolymers.
After loosing a major customer, we are re-aligning our products and
manufacturing dynamics. Accordingly,
these products are still in the preliminary stage of development and are
currently only beginning the process of commercialization. Management is optimistic about the future
prospects of these products and is committed to providing the resources
necessary to fully develop these products.
We performed an analysis through December 30, 2007 incorporating
annualized year to date earnings as well as future projections of cash flow for
this segment based upon sales and cost projections of such products still in
development. We have concluded that no
asset impairment adjustment is necessary.
We continue to analyze our product mix and the related potential of
products still in the development stage.
As such, we continue to monitor our Other segment for potential asset
impairment.
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Item 9A. Controls and Procedures
Evaluation of Controls
and Procedures, age 71
11. We note the qualifying language you have
included in your disclosure controls and procedures disclosure. Please revise your disclosure in future
filings to disclose whether or not your disclosure controls and procedures are
effective as of the end of the period covered by the report without any
qualifying language. We refer you to
Item 307 of Regulation S-K.
We included the following
disclosure in the Evaluation of disclosure controls and procedures under Item 4
of our Quarterly Report on Form 10-Q for the period ended December 30,
2007. We will make similar disclosure in
future filings.
“Our Chief Executive Officer, President and Chief
Financial Officer, after evaluating the design and effectiveness of the
Company’s disclosure controls and
procedures (as defined in Exchange Act Rules 13a-15(e) or 15d-15(e))
as of the end of the period covered by this report (the “Evaluation Date”),
have concluded that as of the Evaluation Date, the Company’s disclosure
controls and procedures were adequately designed and operating effectively to
ensure that material information relating to the Company would be made known to
them by others within the Company.”
Form 10-Q for the
period ended September 30, 2007
Note 1. Basis of
Presentation, page 7
12. We note you have reclassified certain
other operating income into cost of sales.
Tell us more specifically the type transaction being reported and why
you concluded it would be more appropriate to report the expense from these
transactions as cost of sales. Please
tell us whether this was the result of a change in accounting principal
pursuant to paragraph 2.c of SFAS 154.
We included the following
disclosure in Note 1. Basis of Presentation in our Quarterly Report on Form 10-Q
for the period ended December 30, 2007.
We will make similar disclosure in future filings.
“For the quarter and year
to date periods ended December 30, 2007 and December 31, 2006, the
Company has reclassified other operating income into cost of sales. Following a review of the transactions
reported within other operating income, management concluded that it would be
more appropriate to reclassify them within cost of sales because they
relate to amounts received from transactions involving the sale of by-products
or the use of operating assets by third parties which reduce the cost of sales.
As a result, for the quarter ended December 31, 2006, cost of sales and
gross profit previously reported of $71,322,000 and $16,323,000 respectively,
are now reported as $71,147,000 and $16,498,000 respectively. For the year to date period ended
December 31, 2006, cost of sales and gross profit previously reported of
$141,380,000 and $31,260,000, respectively, are now reported as $140,609,000
and $32,031,000, respectively.”
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We considered paragraph
2.c of SFAS 154 in our analysis when we made the reclassification and concluded
that the reclassification, having less than a 1% and 4% impact on cost of sales
and gross profit respectively, was immaterial per paragraph 27 of SFAS 154.
Note 3. Segment Changes, page 7
13. We note you have expanded the number of
operating segments you report from 2 to 3 segments as you “concluded that it
would be more appropriate and would provide the Company’s shareholders with
better information if the Company were to include its pet treat resins and
plant-based biopolymers in a separate segment.”
Please clarify how you determined that the additional segment (i.e.,
Other segment) meets the criteria of an operating segment pursuant to
paragraphs 10 through 15 of SFAS 131. In
this respect, please clarify whether the information reported to your chief
operating decision maker changed in connection with the change in the
reportable segments.
We
undertook a review of the manner in which we reported segments in the fall of
2007. We had begun breaking out our
internal reports to show the profitability contributions of our distillery
products, food products, pet treat resins, plant-based biopolymers and personal care products. We also had undergone an internal
restructuring as a result of which a single individual was given primary
responsibility for sales of our plant-based biopolymers and pet treat
resins. As a result, we considered
whether it was appropriate to continue treating these products as part of our
ingredients segment. For the reasons stated below, we concluded that they did
not appear to share a majority of the aggregation criteria listed in paragraph
17 of FAS 131 with our other ingredients.
· Most of the
products in our prior ingredients segment, including our plant-based biopolymers and pet treat resins, are wheat
based. However, our starches and
proteins generally are sold for human consumption (hence we sometimes refer to
them as food products) whereas our pet treat resins and plant-based biopolymers generally are not. Therefore, it appeared to us that, in at
least one respect, the nature of our plant-based biopolymers and pet treat resins were
different.
· Although most, if not all of our non-distillery
products have the same starting point in the production process, in some
respects the nature of the production process for our plant-based biopolymers
and pet treat resins is different. To
change their form from dry starches or proteins, we have to further process our starch and protein
products to make the pet treat resins and plant-based biopolymers. In addition, although we use
extrusion processes for certain of our ingredients products and some of our pet
treat resins, we use molding technology to make our finished biopolymer and
some of our resin products.
· Although our customers for most of our products are
similar, in the respect that they generally further process our products, we
have developed some retail customers for our pet treat resins and plant-based
biopolymer products.
· We have also developed the capability to wrap certain
of our pet treat resins and plant-based biopolymer products for our retail
customers. We ship to our other
ingredients customers in bulk.
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In
light of these considerations, we concluded that it would be appropriate to
break out our pet treat resins and plant-based
biopolymers from our ingredients segment. At the same time, we felt they were
sufficiently similar to warrant combining into a single segment. They appear to
share commonalties in a majority of the aggregation criteria. Although they do not on a combined basis meet
the quantitative requirements of Paragraph 18 of FAS 131, we concluded that
information about our progress in developing markets for our plant-based biopolymers and pet treat resins would be of interest
to investors.
We
also concluded that it was appropriate to continue including our cosmetic
products with our other ingredients. We
ship these products in bulk, our customers are further processors and, like our
other ingredient products, our cosmetics are used in products made primarily
for human use.
Liquidity and Capital
Resources, page 18
14. We note your non-GAAP EBITDA disclosure
for the period ended September 30, 2007. Please comply with Item 10(e) of
Regulation S-K and Question 8 of the Frequently Asked Questions regarding the
Use of non-GAAP Financial Measures and disclose specifically how your non-GAAP
measure provides investors with meaningful information and how you use EBITDA
as a performance and liquidity measure.
In addition, since you also use EBITDA as a liquidity measure you should
also reconcile the measure to cash flow from operations.
We included the following
disclosure where we provide information about EBITDA in our Quarterly Report on
Form 10-Q for the period ended December 30, 2007. We will make similar disclosure in future
filings. In addition, we will
reconcile the measure to cash flow from operations.
“We have included EBITDA because we believe it
provides investors with additional information to measure our performance and
liquidity. EBITDA is not a recognized
term under generally accepted accounting principles (“GAAP”) and does not
purport to be an alternative to net income as a measure of operating
performance or to cash flows from operating activities as a measure of
liquidity. Additionally, it is not
intended to be a measure of free cash flow for management’s discretionary use,
as it does not consider certain cash requirements such as interest payments,
tax payments and debt service requirements.
Because not all companies use identical calculations, this presentation
may not be comparable to other similarly titled measures of other companies.”
Thank you for
your comments. The Company acknowledges
that
· it is responsible for the adequacy of the
disclosure in the filing;
· staff comments or changes to disclosure in
response to staff comments do not foreclose the Commission from taking any
action with respect to the above referenced filings; and
· the Company may not assert staff comments as
a defense in any proceeding initiated by the Commission or any person under the
federal securities laws of the United States.
Please call me at 913-360-5229 if you have any questions
about our responses.
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Sincerely,
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MGP
Ingredients, Inc.
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By
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/s/
Robert Zonneveld
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Robert
Zonneveld
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Chief
Financial Officer
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