XNAS:MGPI MGP Ingredients Inc Quarterly Report 10-Q Filing - 6/30/2012

Effective Date 6/30/2012

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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C.  20549
 
FORM 10-Q
 
(Mark One)
 
[ X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the quarterly period ended June 30, 2012
 
or
 
[  ]  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
45-4082531
(State or other jurisdiction of incorporation or organization)
(I.R.S. Employer Identification No.)
   
100 Commercial Street, Atchison Kansas
66002
(Address of principal executive offices)
(Zip Code)
 
(913) 367-1480
(Registrant’s telephone number, including area code)
 
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.  [X] Yes [  ] No
 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). [X ] Yes [  ] No
 
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  “large accelerated filer”, “accelerated filer and “smaller reporting company” in Rule 12b-2 of the Exchange Act.  (Check One) [  ] Large accelerated filer  [  ] Accelerated filer
 
[  ]  Non-accelerated filer                                                      [ X] Smaller Reporting Company
 
Indicated by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). [  ]Yes [ X ] No
 
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.
 
Common stock, no par value
17,973,065 shares outstanding
as of August 3, 2012
 
 

 
INDEX
 
     
Page
 
   
   
       
   
   
   
   
   
       
 
       
 
       
 
       
 
   
 
       
 
       
 
       
 
       
 
       
 
       
 
 
 
2

 
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 Quarterly Report on Form 10-Q 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.  Investors should not place undue reliance upon forward-looking statements, and the Company undertakes no obligation to publicly update or revise any forward-looking statements.  Important factors that could cause actual results to differ materially from our expectations include, among others: (i) disruptions in operations at our Atchison facility or Indiana distillery,  (ii) the availability and cost of grain and fluctuations in energy costs, (iii) the effectiveness of our hedging strategy, (iv) our ability to integrate the acquired operations of Lawrenceburg Distillers Indiana, LLC into our own, (v) the competitive environment and related market conditions, (vi) the ability to effectively pass raw material price increases on to customers, (vii) the profitability of the Illinois Corn Processing, LLC (“ICP”) joint venture, (viii) our ability to maintain compliance with all applicable loan agreement covenants, (ix) our ability to realize operating efficiencies, (x) actions of governments and (xi) consumer tastes and preferences.  For further information on these and other risks and uncertainties that may affect our business, see Item 1A. Risk Factors of our Annual Report on Form 10-K for the six month transition period ended December 31, 2011, as updated by Item 1A. Risk Factors of this Quarterly Report on Form 10-Q.

 
METHOD OF PRESENTATION
 
All amounts in this quarterly report, except for shares, units, bushels, gallons, pounds, mmbtu, per share, per bushel and per gallon amounts, are shown in thousands.
 
 
3

 
PART I. FINANCIAL INFORMATION
 
ITEM 1. FINANCIAL STATEMENTS

MGP INGREDIENTS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
 (Unaudited)
(Dollars in thousands, except per-share amounts)

   
Quarter Ended
   
Year to Date Ended
 
   
June 30,
2012
   
June 30,
2011
   
June 30,
2012
   
June 30,
2011
 
                         
Sales
  $ 87,263     $ 68,882     $ 175,693     $ 133,093  
Less:  excise taxes
    1,729       84       3,815       107  
Net sales
    85,534       68,798       171,878       132,986  
Cost of sales (a)
    79,618       71,586       160,383       129,255  
Gross profit (loss)
    5,916       (2,788 )     11,495       3,731  
                                 
Selling, general and administrative expenses
    6,285       4,880       14,033       10,570  
Other operating costs
    176       425       250       425  
Loss from operations
    (545 )     (8,093 )     (2,788 )     (7,264 )
                                 
Gain on sale of joint venture interest
    -       -       4,055       -  
Other income, net
    2       2       4       5  
Interest expense
    (232 )     -       (487 )     (92 )
Equity in earnings (loss) of joint ventures
    (143 )     (2,296 )     294       (2,172 )
Income (loss) before income taxes
    (918 )     (10,387 )     1,078       (9,523 )
                                 
Provision (benefit) for income taxes
    (68 )     (129 )     52       34  
Net income (loss)
    (850 )     (10,258 )     1,026       (9,557 )
                                 
Other comprehensive income (loss), net of tax
    12       2,971       185       2,988  
Comprehensive income (loss)
  $ (838 )   $ (7,287 )   $ 1,211     $ (6,569 )
                                 
Per share data
                               
Total basic earnings (loss) per common  share
  $ (0.05 )   $ (0.61 )   $ 0.06     $ (0.57 )
Total diluted earnings (loss) per common share
  $ (0.05 )   $ (0.61 )   $ 0.06     $ (0.57 )
                                 
Dividends per common share
  $ -     $ -     $ 0.05     $ -  

(a) 
Includes related party purchases of $14,898 and $16,319 for the quarters ended June 30, 2012 and 2011, respectively.  Includes related party purchases of $31,125 and $31,953 for the year to date periods ended June 30, 2012 and 2011, respectively.
 
See accompanying notes to unaudited condensed consolidated financial statements
 
4

 
       MGP INGREDIENTS, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited)
(Dollars in thousands)

   
June 30,
2012
   
December 31,
2011
 
       
             
Current Assets
           
Cash and cash equivalents
  $ -     $ 383  
Restricted cash
    2,757       7,605  
Receivables (less allowance for doubtful accounts: June 30, 2012 - $12; December 31, 2011 - $63)
    35,364       27,804  
Inventory
    36,525       31,082  
Prepaid expenses
    1,087       958  
Derivative assets
    -       1,304  
Deferred income taxes
    5,286       6,056  
Refundable income taxes
    514       566  
Assets held for sale
    -       2,300  
Total current assets
    81,533       78,058  
                 
Property and equipment
    190,367       185,386  
Less accumulated depreciation and amortization
    (113,952 )     (108,307 )
Property and equipment, net
    76,415       77,079  
                 
Investment in joint ventures
    7,889       12,147  
Other assets
    1,675       1,873  
Total assets
  $ 167,512     $ 169,157  
                 
Current Liabilities
               
Current maturities of long-term debt
  $ 1,697     $ 1,670  
Revolving credit facility
    23,380       21,142  
Accounts payable
    22,423       22,704  
Accounts payable to affiliate, net
    4,611       6,167  
Accrued expenses
    5,165       4,023  
Derivative liabilities
    1,764       3,465  
Total current liabilities
    59,040       59,171  
                 
Long-term debt, less current maturities
    5,996       6,852  
Deferred credit
    3,896       4,195  
Accrued retirement health and life insurance benefits
    6,517       6,309  
Other non current liabilities
    1,715       2,144  
Deferred income taxes
    5,286       6,056  
Total liabilities
    82,450       84,727  
                 
Commitments and Contingencies – See Note 5
               
Stockholders’ Equity
               
Capital stock
               
Preferred, 5% non-cumulative; $10 par value; authorized 1,000 shares; issued and outstanding 437 shares
    4       4  
Common stock
               
No par value; authorized 40,000,000 shares; issued 18,115,965 and 19,530,344 shares at June 30, 2012 and December 31, 2011, respectively; 17,973,065 and 18,115,965 shares outstanding at June 30, 2012 and December 31, 2011, respectively
    6,715       6,715  
Additional paid-in capital
    7,344       6,925  
Retained earnings
    71,933       78,953  
Accumulated other comprehensive income (loss)
    (850 )     (1,035 )
Treasury stock, at cost
               
Common; 142,900 and 1,414,379 shares at June 30, 2012 and December 31, 2011, respectively
    (84 )     (7,132 )
Total stockholders’ equity
    85,062       84,430  
Total liabilities and stockholders’ equity
  $ 167,512     $ 169,157  
 
See accompanying notes to unaudited condensed consolidated financial statements
 
5

 
MGP INGREDIENTS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
 (Dollars in thousands)
 
   
Year to Date Ended
 
   
June 30,
2012
   
June 30,
2011
 
Cash Flows from Operating Activities
           
Net income (loss)
  $ 1,026     $ (9,557 )
Adjustments to reconcile net income (loss) to net cash provided by operating activities:
               
Depreciation and amortization
    5,843       4,760  
Gain on sale of joint venture interest
    (4,055 )     -  
Loss on sale of assets
    48       -  
Share based compensation
    419       609  
Equity in (earnings) loss of joint ventures
    (294 )     2,172  
Changes in operating assets and liabilities:
               
Restricted cash
    4,848       (538 )
Receivables, net
    (7,560 )     (6,229 )
Inventory
    (5,443 )     3,885  
Prepaid expenses
    (129 )     (90 )
Refundable income taxes
    52       (41 )
Accounts payable
    (998 )     6,133  
Accounts payable to affiliate, net
    (1,556 )     2,404  
Accrued expenses
    1,058       283  
Change in derivatives
    (270 )     -  
Deferred credit
    (299 )     (597 )
Accrued retirement health and life insurance benefits and other noncurrent liabilities
    (158 )     (613 )
Other
    -       1,542  
Net cash provided by (used in)  operating activities
    (7,468 )     4,123  
                 
Cash Flows from Investing Activities
               
Proceeds from sale of joint venture interest
    9,103       -  
Additions to property and equipment
    (4,245 )     (9,111 )
Proceeds from the disposition of property and  equipment
    2,232       -  
Investment in and advances to unconsolidated subsidiaries
    (500 )     -  
Net cash provided by (used in) investing activities
    6,590       (9,111 )
                 
Cash Flows from Financing Activities
               
Payment of dividends
    (914 )     -  
Purchase of treasury stock
    -       (33 )
Proceeds from stock plans
    -       48  
Exercise of stock options
    -       548  
Proceeds from issuance of long-term debt
    -       7,335  
Principal payments on long-term debt
    (829 )     (351 )
Proceeds from revolving credit facility
    71,095       175,290  
Principal payments on revolving credit facility
    (68,857 )     (170,718 )
Net cash provided by financing activities
    495       12,119  
                 
Increase (decrease) in cash and cash equivalents
    (383 )     7,131  
Cash and cash equivalents, beginning of period
    383       472  
Cash and cash equivalents, end of period
  $ -     $ 7,603  
 
See accompanying notes to unaudited condensed consolidated financial statements
 
6

 
MGP INGREDIENTS, INC.
CONDENSED CONSOLIDATED STATEMENT OF
CHANGES IN STOCKHOLDERS’ EQUITY
(Unaudited)
(Dollars in thousands)
 
   
Capital
Stock
Preferred
   
Issued
Common
   
Additional
Paid-In
Capital
   
Retained
Earnings
   
Accumulated
Other
Comprehensive
Income (Loss)
   
Treasury
Stock
   
Total
 
Balance, December 31,  2011
  $ 4     $ 6,715     $ 6,925     $ 78,953     $ (1,035 )   $ (7,132 )   $ 84,430  
Comprehensive income (loss) :
                                                       
Net income
                            1,026                       1,026  
Change in pension plans
                                    61               61  
Change in post employment Benefits
                                    4               4  
Change in translation adjustment on non-consolidated foreign subsidiary
                                    (7 )             (7 )
Net losses from cash flow hedges
                                    (286 )             (286 )
Losses from cash flow hedges reclassified to cost of sales
                                    186               186  
Losses from de-designated cash flow hedges reclassified to cost of sales
                                    27               27  
Ineffective portion of cash flow hedges reclassified to cost of sales
                                    200               200  
Dividends paid
                            (914 )                     (914 )
Share-based compensation
                    419                               419  
Cancellation of treasury stock
                            (7,132 )             7,132       -  
Stock shares repurchased
                                            (84 )     (84 )
Balance, June 30, 2012
  $ 4     $ 6,715     $ 7,344     $ 71,933     $ (850 )   $ (84 )   $ 85,062  
 
See accompanying notes to unaudited condensed consolidated financial statements
 
7

 
MGP INGREDIENTS, INC.
 
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in thousands, unless otherwise noted)

Note 1.  Accounting Policies and Basis of Presentation.

Reorganization
 
MGP Ingredients, Inc. (formerly named MGPI Holdings Inc.) (herein the “Company” or, when referenced prior to the Reorganization (defined below), referenced to herein as “Holdings,” is a Kansas corporation headquartered in Atchison, Kansas.  It was incorporated in 2011 and is a holding company with no operations of its own.  Its principal, directly-owned, operating subsidiaries are MGPI Processing, Inc. (formerly named MGP Ingredients, Inc.) (“Processing”), and MGPI of Indiana, LLC (formerly named Firebird Acquisitions, LLC) (“MGPI-I”).

On January 3, 2012, Processing reorganized into a holding company structure (the “Reorganization”) as previously disclosed in its consolidated financial statements for the six-month transition period ended December 31, 2011.

As used in these Notes to Unaudited Condensed Consolidated Financial Statements, unless the context otherwise requires, the term “Company” when referenced to after the Reorganization means MGP Ingredients, Inc. (formerly named MGPI Holdings, Inc.) and its consolidated subsidiaries, and the term “Company” when referenced prior to the Reorganization means Processing (formerly named MGP Ingredients, Inc.) and its consolidated subsidiaries.
 
Basis of Presentation and Principles of Consolidation
 
The accompanying unaudited condensed consolidated financial statements of the Company reflect all adjustments (consisting only of normal adjustments) which, in the opinion of the Company’s management, are necessary to fairly present the financial position, results of operations and cash flows of the Company.  All significant intercompany balances and transactions have been eliminated in consolidation.
 
These unaudited condensed consolidated financial statements as of and for the quarter and year to date periods ended June 30, 2012 should be read in conjunction with the consolidated financial statements and notes thereto in the Company’s Transition Report on Form 10-K for the six month transition period ended December 31, 2011 filed with the SEC.  The results of operations for interim periods are not necessarily indicative of the results to be expected for the full year.

Use of Estimates

The preparation of the condensed consolidated financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the consolidated financial statements, and the reported amounts of revenues and expenses during the reporting period.  Actual results could differ from those estimates.

 
8

 
Derivative Instruments

The Company applies the provisions of Accounting Standards Codification (“ASC”) 815 – Derivatives and Hedging.  The Company uses derivative financial instruments primarily to offset exposure to market risk in commodity prices, primarily for corn and ethanol, which are key components in the Company’s operations.  The Company recognizes all derivatives as either assets or liabilities at their fair values.  Accounting for changes in the fair value of a derivative depends on whether the derivative has been designated as a cash flow hedge and the effectiveness of the hedging relationship.  Derivatives qualify for treatment as cash flow hedges for accounting purposes when there is a high correlation between the change in fair value of the hedging instrument (“derivative”) and the related change in value of the underlying commitment (“hedged item”).  For derivatives that qualify as cash flow hedges for accounting purposes, except for ineffectiveness, the change in fair value has no net impact on earnings, to the extent the derivative is considered effective, until the hedged item or transaction affects earnings.  For derivatives that are not designated as hedging instruments for accounting purposes, or for the ineffective portion of a hedging instrument, the change in fair value affects current period net earnings.  While management believes that each of these instruments are primarily entered to effectively manage various market risks, none of the open derivative contracts entered into prior to July 1, 2011 were designated and accounted for as cash flow accounting hedges.
 
Effective July 1, 2011, management elected to restart hedge accounting for qualifying derivative contracts entered on or after July 1, 2011.  On the date a derivative contract is entered, the Company is required to designate the derivative as a hedge of variable cash flows to be paid with respect to certain forecasted cash purchases of commodities used in the manufacturing process (a “cash-flow hedge”).  This accounting requires linking all derivatives that are designated as cash-flow hedges to specific firm commitments or forecasted transactions.  For cash flow hedging relationships entered on and after July 1, 2011, to qualify for cash flow hedge accounting, the Company formally documents the hedging relationship and its risk management objective and strategy for undertaking the hedge transactions, the hedging instrument, the hedged item, the nature of the risk hedged, the hedging instrument’s effectiveness in offsetting the hedged risk, and a description of the method utilized to measure ineffectiveness.  The Company must also formally assess, both at the cash-flow hedge’s inception and on an ongoing basis, whether the derivatives that are used in hedging transactions are highly effective in offsetting changes in the expected cash flows of hedged items.  Changes in fair value of contracts that qualify as cash-flow hedges that are highly effective are marked to fair value as derivative assets or derivative liabilities with the offset recorded to accumulated other comprehensive income (loss) (“AOCI”).  Gains and losses on commodity hedging contracts are reclassified from AOCI to current earnings when the finished goods produced using the hedged item are sold.  The maximum term over which the Company hedges exposures to the variability of cash flows for commodity price risk is generally 12 months; however, the Company may choose to hedge qualifying exposures in excess of 12 months should market conditions warrant.  The ineffective portion of the change in fair value of a derivative instrument that qualifies as a cash-flow hedge is reported in current period earnings.
 
The Company discontinues cash-flow hedge accounting for a particular derivative instrument prospectively when (i) it determines that the derivative is no longer considered to be highly effective in offsetting changes in the expected cash flows of the hedged item; (ii) the derivative is sold, terminated or exercised; (iii) it de-designates the derivative as a hedging instrument because it is unlikely that a forecasted transaction will occur; or (iv) it determines that designation of the derivative as a hedging instrument is no longer appropriate. When cash flow hedge accounting is discontinued, the Company continues to carry the derivative on the Condensed Consolidated Balance Sheet at its fair value, and gains and losses that were included in AOCI are deferred until the original hedged item affects earnings. However, if the original hedged transaction is no longer probable of occurring, the related gains and losses incurred as of discontinuation are recognized in current period earnings.  During February 2012, the Company de-designated its cash flow hedges.

 
9

 
Inventory

Inventory includes finished goods, raw materials in the form of agricultural commodities used in the production process and certain maintenance and repair items.  Inventories are stated at the lower of cost or market on the first-in, first-out (“FIFO”) method.  Inventory consists of the following:

   
June 30,
2012
   
December 31,
2011
 
             
Finished goods
  $ 16,038     $ 15,728  
Barreled whiskey and bourbon
    7,133       2,473  
Raw materials
    5,692       5,352  
Work in process
    2,859       3,529  
Maintenance materials
    4,030       3,468  
Other
    774       532  
Total
  $ 36,525     $ 31,082  
 
Assets Held for Sale
 
The Company records assets held for sale at the lower of the carrying value or estimated fair value less costs to sell. In determining the fair value of the assets less cost to sell, the Company considers factors including current appraisals and any recent legitimate offers. If the estimated fair value less cost to sell of an asset is less than its current carrying value, the asset is written down to its estimated fair value less cost to sell. Depreciation is discontinued when assets are classified as held for sale.

Investment in Joint Ventures

The Company applies the provisions of ASC 810 – Improvements to Financial Reporting by Enterprises Involved with Variable Interest Entities, which includes a qualitative approach to identifying a controlling financial interest in a variable interest entity and determination of the primary beneficiary.

The Company accounts for its investment in non-consolidated subsidiaries under the equity method of accounting when the Company has significant influence, but does not have more than 50% voting control, and is not considered the primary beneficiary.  Under the equity method of accounting, the Company reflects its investment in non-consolidated subsidiaries within the Company’s Condensed Consolidated Balance Sheets as “Investment in joint ventures”; the Company’s share of the earnings or losses of the non-consolidated subsidiaries are reflected as “Equity in earnings (loss) of joint ventures” in the Condensed Consolidated Statements of Comprehensive Income (Loss).

Revenue Recognition
 
Revenue from the sale of the Company’s products is recognized as products are delivered to customers according to shipping terms and when title and risk of loss have transferred.
 
The Company routinely produces whiskey and bourbon and this product is frequently barreled and warehoused at a Company location for an extended period of time in accordance with directions received from the Company’s customers.   This product must meet customer acceptance specifications, the risks of ownership and title for these goods must be passed and requirements for bill and hold revenue recognition must be met prior to the Company recognizing revenue for this product.  Separate warehousing agreements are typically maintained for customers who store their product with the Company and warehouse revenues are recognized as the service is provided. 
 
 
10

 
Sales include customer paid freight costs billed to customers of $3,236 and $2,986 for the quarters ended June 30, 2012 and 2011, respectively, and $5,119 and $5,879 for the year to date periods ended June 30, 2012 and 2011, respectively.
 
Income Taxes
 
The effective tax rate for the quarters ended June 30, 2012 and 2011 was 7.4 percent and 1.2 percent, respectively.  The effective tax rate for the year to date periods ended June 30, 2012, and 2011 was 4.8 percent and (0.4) percent, respectively.
 
For the quarters and year to date periods ended June 30, 2012 and June 30, 2011, the effective rate differed from the Company’s statutory rate primarily due to the expected change in the Company’s valuation allowance against available net operating losses and the effects of state income taxes for which no operating loss carryovers are available.  At this time, management is unable to conclude it is more likely than not that deferred tax assets will be realized.  As a result of this analysis, the Company continues to record a full valuation allowance on net deferred tax assets.  Management will continue to evaluate the available positive and negative evidence in future periods.  Depending on management’s ongoing assessment of realization of its tax attributes, it is possible that all or a portion of the valuation allowance will be reversed which would positively impact income in the future periods.
 
Earnings (loss) per Share
 
The Company applies the provisions of ASC 260 - Earnings per share. Basic and diluted earnings (loss) per share are computed using the two-class method, which is an earnings allocation formula that determines net income (loss) per share for each class of common stock and participating security according to dividends declared and participation rights in undistributed earnings. Per share amounts are computed by dividing net income (loss) from continuing operations attributable to common shareholders by the weighted average shares outstanding during each period.

The Company identified an immaterial error in its computation of loss per share for the quarter ended and year ended June 30, 2011.  For both the quarter and year ended June 30, 2011, the Company had incorrectly allocated the net loss to each class of common stock and participating security under the two-class method. The net loss for each of these periods should have been fully allocated to the class of common stock.  The impact of this immaterial error correction is to change loss per share for the quarter ended June 30, 2011 to $(0.61) from $(0.58) as previously reported and to change loss per share for the year ended June 30, 2011 to $(0.08) from $(0.07) as previously reported.  Note that because the Company changed its fiscal year end from June 30 to December 31, the loss per share for the year ended June 30, 2011 is not presented in this Form 10-Q for the quarterly period ended June 30, 2012.  The Company does not believe that this adjustment is material to any of its previously-filed quarterly or annual consolidated financial statements.

Impairment

The Company tests its long-lived assets for impairment whenever events or conditions and circumstances indicate a carrying amount of an asset may not be recoverable.  No events or conditions occurred during the quarterly period ended June 30, 2012 that required the Company to record an impairment.

 
11

 
Dividends

On March 1, 2012, the Board of Directors declared a dividend of $0.05 per share of the Company’s common stock, no par value (the “Common Stock”), payable to stockholders of record of Common Stock on March 22, 2012.  This $914 dividend was paid on April 19, 2012.

Reclassifications

Historically, the Company recorded the collection of excise taxes on distilled products sold to customers as accrued expenses and no revenue or expense was recognized in the Condensed Consolidated Statements of Comprehensive Income (Loss).  With the Company’s acquisition of the distillery operations of Lawrenceburg Distillers Indiana, LLC (“LDI”) on December 27, 2011, the Company is now subject to more excise taxes.  In the quarter ended March 31, 2012, because excise taxes exceeded 1 percent of net sales, the Company began to present excise taxes as a caption on the Condensed Consolidated Statements of Comprehensive Income (Loss), which is a reduction to gross sales.  The prior quarter and year to date period ended have been conformed to the current presentation.  This reclassification had no impact on net loss or reported loss per share.

Note 2.  Recently Issued Accounting Pronouncements.

Fair Value Measurements and Disclosures

In May 2011, the FASB issued ASU 2011-04, Fair Value Measurement (Accounting Standards Codification (“ASC”) Topic 820) - Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs (“ASU 2011-04”).  The amendments in ASU 2011-04 result in common fair value measurement and disclosure requirements in U.S. GAAP and international financial reporting standards (“IFRS”). Consequently, the amendments change the wording used to describe many of the requirements in U.S. GAAP for measuring fair value and for disclosing information about fair value measurements. To improve consistency in application across jurisdictions, some changes in wording are necessary to ensure that U.S. GAAP and IFRS fair value measurement and disclosure requirements are described in the same way. ASU 2011-04 also provides for certain changes in current U.S. GAAP disclosure requirements, for example with respect to the measurement of level 3 assets and for measuring the fair value of an instrument classified in a reporting entity’s shareholders’ equity. The amendments in ASU 2011-04 are to be applied prospectively.  The adoption of this accounting standard effective January 1, 2012 did not have a material impact on the Company’s accounting or disclosures.

      Presentation of Comprehensive Income

       In June 2011, the FASB issued ASU 2011-05, Presentation of Comprehensive Income (“ASU 2011-05”), which requires that comprehensive income and the related components of net income and other comprehensive income be presented either in a single continuous statement of comprehensive income or in two separate but consecutive statements. ASU 2011-05 also requires reclassification adjustments from other comprehensive income to net income be presented on the face of the financial statements. However, in December 2011, the FASB issued ASU 2011-12, Deferral of the Effective Date for Amendments to the Presentation of Reclassifications of Items Out of Accumulated Other Comprehensive Income in ASU 2011-05 to defer the requirement to present reclassification adjustments from other comprehensive income on the face of the financial statements and allow entities to continue to report reclassifications out of accumulated other comprehensive income consistent with the requirements in effect before ASU 2011-05.  The adoption of these standards effective January 1, 2012 resulted only in changes to the presentation of the Company’s financial statements, with net income (loss) and other comprehensive income (loss) reported in a single, continuous statement, and did not have an impact on the Company’s financial position, results of operations or cash flows.

 
12

 
Note 3.  Investment in Joint Ventures.

At June 30, 2012, the Company’s investments accounted for using the equity method of accounting consisted of the following: (1) 30 percent interest in Illinois Corn Processing, LLC (“ICP”), which operates a distillery, and (2) 50 percent interest in D.M. Ingredients, GmbH (“DMI”), which produces certain specialty starch and protein ingredients.   

On February 1, 2012, Illinois Corn Processing Holdings (“ICP Holdings”), an affiliate of SEACOR Energy, Inc., exercised its option to purchase from the Company an additional 20 percent of the membership interest in ICP.  The proceeds for this sale approximated $9,103.  Following its exercise, ICP Holdings owns 70 percent of ICP, is entitled to name 4 of ICP’s 6 advisory board members, and generally has control of ICP’s day-to-day operations.  The Company owns 30 percent of ICP and is entitled to name two of ICP’s six advisory board members.   The transaction resulted in a pre-tax gain of $4,055, which was recorded during the quarter ended March 31, 2012.

Maximum Exposure to Loss

On January 29, 2010, ICP acquired the steam facility that services its operations for $5,000, of which approximately $2,000 remained payable at December 31, 2011.  On January 19, 2012, $1,000 was paid, equally by the Company and SEACOR Energy Inc., leaving at June 30, 2012, $1,000 still payable.  The Company’s portion of the remaining commitment of $500 plus the Company’s investment balance is the maximum exposure to losses.  A reconciliation from the Company’s investment in ICP to the entity’s maximum exposure to loss is as follows:
 
   
June 30,
2012 (a)
   
December 31,
2011
 
Company’s investment balance in ICP
  $ 7,594     $ 11,777  
Plus:
               
Funding commitment for capital Improvements
    500       1,000  
The Company’s maximum exposure to loss related to ICP
  $ 8,094     $ 12,777  
 
(a) 
The Company’s investment balance in ICP at June 30, 2012 reflects its sale of a 20 percent interest effective February 1, 2012.

Summary Financial Information

Condensed financial information of the Company’s non-consolidated equity method investment in ICP is shown below.

   
Quarter Ended
   
Year to Date Ended
 
   
June 30,
2012
   
June 30,
2011
   
June 30,
2012
   
June 30,
2011
 
ICP’s Operating results:
                       
Net sales (a)
  $ 58,938     $ 55,008     $ 116,991     $ 112,574  
Cost of sales and expenses (b)
    (59,307 )     (59,633 )     (116,232 )     (117,042 )
Net income (loss)
  $ (369 )   $ (4,625 )   $ 759     $ (4,468 )
 
(a)
Includes related party sales to MGPI of $14,638 and $15,574 for the quarters ended June 30, 2012 and 2011, respectively, and $30,633 and $31,837 for the year to date periods ended June 30, 2012 and 2011, respectively.
(b)
Includes depreciation and amortization of $1,259 and $1,294 for the quarters ended June 30, 2012 and 2011, respectively, and $2,519 and $2,583 for the year to date periods ended June 30, 2012 and 2011, respectively.
 
 
13

 
 
The Company’s equity in earnings (loss) of joint ventures is as follows:

   
Quarter Ended
   
Year to Date Ended
 
   
June 30,
2012
   
June 30,
2011
   
June 30,
2012
   
June 30,
2011
 
                         
ICP (30% interest)(a)
  $ (110 )   $ (2,313 )   $ 363     $ (2,234 )
DMI (50% interest)
    (33 )     17       (69 )     62  
    $ (143 )   $ (2,296 )   $ 294     $ (2,172 )
 
(a)
The Company’s ownership percentage of ICP was 50 percent through February 1, 2012, when the Company sold a 20 percent interest of its investment.  From February 2, 2012 through June 30, 2012, the Company’s ownership percentage in ICP was 30 percent.

 
The Company’s investment in joint ventures is as follows:

   
June 30,
2012
   
December 31,
2011
 
             
ICP (30% interest) (a)
  $ 7,594     $ 11,777  
DMI (50% interest)
    295       370  
    $ 7,889     $ 12,147  
 
(a)
The Company’s ownership percentage of ICP was 50 percent through February 1, 2012, when the Company sold a 20 percent interest of its investment.  From February 2, 2012 through June 30, 2012, the Company’s ownership percentage in ICP was 30 percent.


 
14

 
Note 4.  Earnings (loss) per Share.

The computations of basic and diluted earnings (loss) per share from continuing operations are as follows:
 
   
Quarter Ended
   
Year to Date
 
   
June 30,
2012
   
June 30,
2011
   
June 30,
2012
   
June 30,
2011
 
                         
Net income (loss) from continuing operations attributable to shareholders
  $ (850 )   $ (10,258 )   $ 1,026     $ (9,557 )
Amounts allocated to participating securities (nonvested shares and units) (i)
    -       -       (67 )     -  
Net income (loss) from continuing operations attributable to common shareholders
  $ (850 )   $ (10,258 )   $ 959     $ (9,557 )
                                 
Basic weighted average common shares(ii)
    16,916,304       16,752,771       16,916,304       16,675,254  
Potential dilutive securities(iii)
    -       -       1,962       -  
Diluted weighted average common shares
    16,916,304       16,752,771       16,918,266       16,675,254  
                                 
Earnings (loss) per share from continuing operations attributable to common shareholders
                               
Basic
  $ (0.05 )   $ (0.61 )   $ 0.06     $ (0.57 )
Diluted
  $ (0.05 )   $ (0.61 )   $ 0.06     $ (0.57 )
 
(i)  
Participating securities include 998,143 and 1,088,644 nonvested restricted shares for the quarters and year to date periods ended June 30, 2012 and 2011, respectively, as well as 200,764 and 0 restricted share units for the quarters and year to date periods ended June 30, 2012 and 2011, respectively.
(ii)  
Under the two-class method, basic weighted average common shares exclude outstanding nonvested participating securities consisting of restricted share awards of 998,143 and 1,088,644 for the quarters and year to date periods ended June 30, 2012 and 2011, respectively.
(iii)  
Anti-dilutive shares related to stock options totaled 20,000 and 18,000 for the quarters ended June 30, 2012 and 2011, respectively, and 19,000 and 14,000 for the year to date periods ended June 30, 2012 and 2011, respectively.  Potential dilutive securities have not been included in the earnings (loss) per share computation in a period when a loss was experienced.

Note 5.  Commitments and Contingencies.

Commitments

The Company has grain supply agreements to purchase its corn requirements for each of its Indiana Distillery and Atchison facility through a single elevator company.  These grain supply agreements expire December 31, 2014 and thereafter will automatically renew each year on March 31.  At June 30, 2012, the Company had commitments to purchase bushels of corn to be used in operations through January 31, 2013 totaling $20,428.

The Company has commitments to purchase approximately 1,165,000 mmbtu of natural gas at fixed prices at various dates through January 2013.  The commitment for these contracts at June 30, 2012 totaled approximately $4,269.
 
The Company has entered into a supply contract for flour for use in the production of protein and starch ingredients.  The initial term of the agreement, as amended, expires October 23, 2015.  At June 30, 2012, the Company had commitments to purchase approximately 24,319,000 pounds of flour, which extend through December 31, 2012, aggregating approximately $4,657.
 
At June 30, 2012, the Company had $500 outstanding from a letter of credit.
 
Contingencies

There are various legal proceedings involving the Company and its subsidiaries that are ordinary and routine in nature for an entity in the Company’s business.  Management considers that the aggregate liabilities, if any, arising from such actions would not have a material adverse effect on the consolidated financial position or overall trends in results of operations of the Company.
 
 
15

 
Note 6.  Derivative Instruments and Fair Value Measurements.

Derivative Instruments.  Certain commodities the Company uses in its production process are exposed to market price risk due to volatility in the prices for those commodities.  The Company uses financial derivative instruments to reduce exposure to market risk in commodity prices, primarily corn and ethanol, through a combination of forward purchases, long-term contracts with suppliers and exchange traded commodity futures and option contracts.  Specifically, the Company will sell put options on commodity futures at exercise prices that are deemed attractive to the Company and use the premiums received to reduce the overall cost of inputs utilized in the production process.  Beginning July 1, 2011, the Company began to buy and sell derivative instruments to manage market risk associated with purchases of product priced as a function of ethanol prices, including ethanol futures and option contracts.  These contracts were entered into to mitigate risks associated with the Company’s investment in ICP.  Effective July 1, 2011, management elected to restart hedge accounting for qualifying derivative contracts entered into on and after July 1, 2011.  No ethanol futures or option contracts have been designated as hedges as of June 30, 2012.

During the quarter ended March 31, 2012, the Company entered into a grain supply contract for its distillery in Indiana that permits the Company to purchase corn for delivery up to 12 months in the future, at fixed prices.  During the quarter ended June 30, 2012, the Company extended this grain supply agreement used for its distillery in Indiana to its Atchison facility.  The pricing for these contracts is based on a formula using several factors.  The Company has determined that the firm commitments to purchase corn under the terms of these new contracts meet the normal purchases and sales exception as defined under ASC 815, Derivatives and Hedging, and has excluded the fair value of these commitments from recognition within its condensed consolidated financial statements until the actual contracts are physically settled.  Accordingly, given these purchase agreements, in February 2012, the Company made the decision to close out of the corn futures contracts designated as cash flow hedges prior to their scheduled delivery and simultaneously de-designated 100 percent of these cash flow hedges at that time.

As of June 30, 2012, the Company has no futures contracts designated as cash flow hedges.

Derivatives Not Designated as Hedging Instruments

The Company’s production process involves the use of natural gas and raw materials including flour and corn.  The contracts for raw materials and natural gas range from monthly contracts to multi-year supply arrangements; however, because the quantities involved have always been for amounts to be consumed within the normal production process, the Company has determined that these contracts meet the normal purchases and sales exception as defined under ASC 815, Derivatives and Hedging, and have excluded the fair value of these commitments from recognition within its condensed consolidated financial statements until the actual contracts are physically settled.   See Note 5. Commitments and Contingencies for discussion on the Company’s natural gas and raw materials purchase commitments.

 
16

 
The following table provides the gain or (loss) for the Company’s commodity derivatives not designated as hedging instruments and where it was recognized in the Condensed Consolidated Statements of Comprehensive Income.

     
Quarter Ended
   
Year to Date Ended
 
 
 
Classified
 
June 30,
2012
   
June 30,
2011
   
June 30,
2012
   
June 30,
2011
 
Commodity derivatives
Cost of sales
  $ 361     $ (2,450 )   $ (466 )   $ 2,696  

 
The Company has used corn futures contracts for the purchase of corn and has also used call and put options in order to mitigate the impact of potential changes in market conditions.  Beginning July 2011, the Company began to buy and sell derivative instruments to manage market risk associated with purchases of product priced as a function of ethanol prices, including ethanol futures and option contracts, in order to mitigate risks associated with the Company’s investment in ICP.  At June 30, 2012, the Company had 10,498,000 gallons (maturing through December 2012) of derivative contracts not designated as hedging instruments.

Derivatives Designated as Cash Flow Hedges

The Company, from time to time, has used futures or options contracts to fix the purchase price of anticipated volumes of corn to be purchased and processed in a future month.  The Company’s corn processing plants currently grind approximately 1,750,000 bushels of corn per month.  From July 1, 2011 until January 27, 2012, when the grain supply contracts became operative, the Company typically entered into cash flow hedges to cover between 70 percent and 80 percent of its monthly anticipated grind.  As previously discussed, in connection with the Company’s new grain supply agreements, the Company de-designated its cash flow hedges and had no corn futures contracts at June 30, 2012.

   
Amount of Gains (Losses) Recognized in OCI on Derivatives
 
   
Quarter Ended
   
Year to Date Ended
 
Derivatives
in Cash Flow Hedging
Relationship
 
June 30,
2012
   
June 30,
2011
   
June 30,
2012
   
June 30,
2011
 
Commodity derivatives
    -       n/a     $ (286 )     n/a  


   
Amount of Gains (Losses) Reclassified from AOCI into Earnings
 
   
Quarter Ended
   
Year to Date Ended
 
Location of Losses Reclassified from AOCI into Income
 
June 30,
2012
   
June 30,
2011
   
June 30,
2012
   
June 30,
2011
 
Cost of sales
    -       n/a     $ (413 )     n/a  
 
During the quarter ended March 31, 2012, the Company de-designated 100 percent of its cash flow hedges, which resulted in a reclassification of a $27 loss from AOCI into current period earnings.  The Company also reclassified $200 of net losses deferred in AOCI, prior to the de-designation, to cost of sales as a result of cash flow hedge ineffectiveness.  
 
17

 
Fair Value Measurements. In accordance with ASC 820, Fair Value Measurements and Disclosures, the fair value of an asset is considered to be the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. ASC 820 also establishes a three-level fair value hierarchy that prioritizes the inputs used to measure fair value. The fair value hierarchy gives the highest priority to quoted market prices (Level 1) and the lowest priority to unobservable inputs (Level 3). The three levels of inputs used to measure fair value are as follows:

 
 
Level 1—quoted prices in active markets for identical assets or liabilities accessible by the reporting entity.
 
 
 
Level 2—observable inputs other than quoted prices included in Level 1, such as quoted prices for similar assets and liabilities in active markets; quoted prices for identical or similar assets and liabilities in markets that are not active; or other inputs that are observable or can be corroborated by observable market data.
 
 
 
Level 3—unobservable inputs for an asset or liability. Unobservable inputs should only be used to the extent observable inputs are not available.
 
The following table shows the fair value of the Company’s derivatives (both designated and non-designated hedging instruments), where the derivatives are classified on the Condensed Consolidated Balance Sheets and the level, within the fair value hierarchy at both June 30, 2012 and December 31, 2011.

           
Fair Value Measurements
 
 
Classified
 
Total
   
Level 1
   
Level 2
   
Level 3
 
June 30, 2012
                         
Liabilities
                         
Ethanol Derivatives
Derivative Liabilities
  $ (1,764 )   $ (1,764 )   $ -     $ -  
                                   
December 31, 2011
                                 
Assets
                                 
Corn Derivatives
Derivative Assets
  $ 1,091     $ 1,091     $ -     $ -  
Ethanol Derivatives
Derivative Assets
  $ 213     $ 213     $ -     $ -  
                                   
                                   
Liabilities                                  
Corn Derivatives
Derivative Liabilities
  $ (974 )   $ ( 974 )   $ -     $ -  
Ethanol Derivatives
Derivative Liabilities
  $ (2,491 )   $ (2,491 )   $ -     $ -  


 
18

 
FASB ASC 825, Financial Instruments, requires the disclosure of the estimated fair value of financial instruments. The Company’s short-term financial instruments include cash and cash equivalents, accounts receivable, accounts payable and a revolving credit facility.  The carrying value of the short-term financial instruments approximates the fair value due to their short-term nature. These financial instruments have no stated maturities or they have short-term maturities that approximate market.

The fair value of the Company’s debt is estimated based on current market interest rates for debt with similar maturities and credit quality. The fair value of the Company’s debt was $7,761 and $8,647 at June 30, 2012 and December 31, 2011, respectively. The financial statement carrying value was $7,693 and $8,522 at June 30, 2012 and December 31, 2011, respectively.  These fair values are considered Level 2 under the fair value hierarchy.

Counterparty credit risk.  The Company enters into commodity derivatives through a broker with a diversified group of counterparties.  Under the terms of the Company’s account with its broker, it is required to maintain a cash margin account as collateral to cover any shortfall in the market value of derivatives.

The Company classifies certain interest bearing cash accounts on deposit with and maintained with the Company’s broker for exchange-traded commodity instruments, which totaled $2,757 and $7,605 at June 30, 2012 and December 31, 2011, respectively, as restricted cash to reflect the fair value of open contract positions relative to respective contract prices.  The Company is also required to provide required margin, serving as collateral, in accordance with commodity exchange requirements which totaled $962 and $4,680 at June 30, 2012 and December 31, 2011, respectively.

Note 7.  Operating Segments.

The Company’s operations are classified into three reportable segments:  distillery products, ingredient solutions and other. The distillery products segment consists of food grade alcohol, along with fuel grade alcohol, commonly known as ethanol, and distillers feed, which are co-products of the Company’s distillery operations.  Ingredient solutions consist of specialty starches and proteins, commodity starch and vital wheat gluten (commodity protein).  The other segment products are comprised of plant-based polymers and composite resins manufactured through the further processing of certain of the Company’s proteins and starches and wood.
 
 
19

 
Operating profit (loss) for each segment is based on net sales less identifiable operating expenses.  Non-direct selling, general and administrative, interest expense, investment income and other general miscellaneous expenses have been excluded from segment operations and classified as Corporate.   Receivables, inventories and equipment have been identified with the segments to which they relate.  All other assets are considered as Corporate.
 
   
Quarter Ended
   
Year to Date Ended
 
   
June 30,
2012
   
June 30,
2011
   
June 30,
2012
   
June 30,
2011
 
                         
Net Sales to Customers
                       
Distillery products
  $ 71,196     $ 52,965     $ 143,681     $ 103,293  
Ingredient solutions
    14,090       15,604       27,668       29,178  
Other
    248       229       529       515  
Total
    85,534       68,798       171,878       132,986  
                                 
Depreciation and amortization
                               
Distillery products
    1,384       1,246       2,768       2,520  
Ingredient solutions
    646       598       1,296       1,153  
Other
    61       62       122       164  
Corporate
    817       632       1,657       923  
Total
    2,908       2,538       5,843       4,760  
                                 
Income (Loss) before Income Taxes
                         
Distillery products
    3,762       (3,712 )     6,448       4,294  
Ingredient solutions
    987       (136 )     2,624       (35 )
Other
    (150 )     (209 )     (246 )     (385 )
Corporate(i)
    (5,517 )     (6,330 )     (11,802 )     (13,397 )
Gain on sale of joint venture interest(i)
    -       -       4,055       -  
Total
  $ (918 )   $ (10,387 )   $ 1,078     $ (9,523 )
 
(i)  
The Company’s management reporting does not assign or allocate special charges to the Company’s operating segments.  For purposes of comparative analysis, gain on sale of joint venture interest for the year to date period ended June 30, 2012 has been excluded from the Company’s segments.

   
As of June 30,
 2012
   
As of December 31,
2011
 
Identifiable Assets
           
Distillery products
  $ 96,342     $ 92,881  
Ingredient solutions
    28,788       26,937  
Other
    256       348  
Corporate
    42,126       48,991  
Total
  $ 167,512     $ 169,157  


 
20

 
Note 8.  Employee Benefit Plans.
 
Post Retirement Benefits.  The Company and its subsidiaries provide certain post-retirement health care and life insurance benefits to certain retired employees.  The liability for such benefits is unfunded.

The components of the Net Periodic Benefit Cost for the quarter and year to date periods ended June 30, 2012 and 2011, respectively, are as follows:
 
   
Quarter Ended
   
Year to Date Ended
 
   
June 30,
2012
   
June 30,
2011
   
June 30,
2012
   
June 30,
2011
 
                         
Service cost
  $ 56     $ 56     $ 112     $ 112  
Interest cost
    59       102       118       204  
Prior service cost
    (4 )     (4 )     (8 )     (8 )
Loss
    -       22       -       44  
Total post-retirement benefit cost
  $ 111     $ 176     $ 222     $ 352  
 
The Company previously disclosed in its financial statements for the six-month transition period ended December 31, 2011, amounts expected to be paid to plan participants.  There have been no revisions to these estimates and there have been no changes in the estimate of total employer contributions expected to be made for the year ended December 31, 2012.
 
Total employer contributions accrued for the quarter ended June 30, 2012 were $111.
 
Pension Benefits.  The Company and its subsidiaries also provide defined retirement benefits to certain employees covered under collective bargaining agreements.  Under the collective bargaining agreements, the Company’s pension funding contributions are determined as a percentage of wages paid.  The funding is divided between the defined benefit plans and a union 401(k) plan.  It has been management’s policy to fund the defined benefit plans in accordance with the collective bargaining agreements.  The collective bargaining agreements allow the plans’ trustees to develop changes to the pension plan to allow benefits to match funding, including reductions in benefits.  The benefits under these pension plans are based upon years of qualified credited service; however benefit accruals under the Atchison plan were frozen as of October 15, 2009 and benefit accruals under the Pekin plan were frozen as of December 10, 2009.
 
 
21

 
The components of the Net Periodic Benefit Cost/(Income) for the quarter and year to date periods ended June 30, 2012 and 2011, respectively, are as follows:
 
   
Quarter Ended
   
Year to Date Ended
 
   
June 30,
2012
   
June 30,
2011
   
June 30,
2012
   
June 30,
2011
 
                         
Service cost
  $ -     $ -     $ -     $ -  
Interest cost
    51       59       102       118  
Expected return on plan assets
    (57 )     (49 )     (114 )     (98 )
Prior service cost
    -       -       -       -  
Recognition of net loss
    28       34       56       68  
Total pension benefit cost
  $ 22     $ 44     $ 44     $ 88  
 
The Company previously disclosed in its financial statements for the six-month transition period ended December 31, 2011, the assumptions used to determine accumulated benefit obligation.
 
The Company has made no employer contributions to pension plan or union 401(k) during the quarter ended June 30, 2012.
 
Equity-Based Compensation Plans.  The Company previously disclosed in its financial statements for the six-month transition period ended December 31, 2011, a description of the Company’s equity-based compensation plans.
 
The Company’s equity-based compensation plans provide for the awarding of shares of restricted common stock (“restricted stock” or “nonvested shares”) for senior executives and certain salaried employees as well as outside directors.  As of June 30, 2012, 998,143 shares of restricted common stock (net of forfeitures) remained outstanding under the Company’s long-term incentive plans.  Compensation expense related to these awards is based on the market price of the stock on the date the Board of Directors approved the grant and is amortized over the vesting period of the restricted stock award. 
 
In connection with the Reorganization, the Director’s Stock Plan was amended to provide for grants in the form of restricted stock units instead of restricted stock.  In contrast to restricted stock awards, shares will not be issued (and participants will not have voting or dividend rights) before awards vest and are issued.  However, the Director’s Stock Plan provides for the payment of cash dividend equivalents when dividends are paid to stockholders.

The Company has heretofore made annual restricted stock awards under its 2004 Incentive Plan.  At meetings held on March 1, 2012, the Human Resources and Compensation Committee and the Board of Directors approved awards in the form of restricted stock units, consisting of 129,000 units awarded as part of the Company’s existing long-term incentive program and 45,000 units awarded as a special bonus for effort in connection with the acquisition of the distillery operations of LDI that was completed in December 2011.  These awards, which had a $6.40 per unit fair value and aggregated $1,114, are being amortized over a 5-year vesting period.  These awards entitle participants to receive an aggregate of 174,000 shares of stock following the end of the 5-year vesting period.  Full or pro rata accelerated vesting generally may occur upon a “change in the ownership” of the Company or the subsidiary for which a participant performs services,  a “change in effective control” of the Company or a “change in the ownership of a substantial portion of the assets” of the Company (in each case, generally as defined in the Treasury regulations under Section 409A of the Internal Revenue Code),  or if employment of a participant is terminated as a result of death, disability, retirement or termination without cause. Participants have no voting or dividend rights under the awards; however, the awards provide for payment of cash dividend equivalents when dividends are paid to stockholders.
 
 
22

 
In June 2012, under the Directors’ Stock Plan, 31,264 restricted stock units were awarded to outside directors of the Company.  These awards, which had a $3.14 per unit fair value and aggregated $98, are being amortized over a 3-year vesting period.

As of June 30, 2012, the Company was authorized to issue 40,000,000 shares of Common Stock.  In connection with the Reorganization described in Note 1, Processing’s 1,414,379 treasury shares were canceled, which also reduced the number of issued shares by 1,414,379.  The Company accounted for the cancellation of treasury stock as a charge to retained earnings, which reduced both treasury stock and retained earnings by $7,132.  The Company had historically used this treasury stock for issuance of Common Stock under the Company’s equity-based compensation plans.  With the retirement of these treasury shares, the Company reserved certain authorized shares for issuance of Common Stock under its equity-based compensation plans.  Reserved shares of Common Stock at June 30, 2012 were as follows:

Stock options granted but not exercised
    42,000  
Restricted stock to non-employees  (authorized but not granted)
    71,061  
Restricted stock to employees and executives (authorized but not granted)
    1,416,778  
Total
    1,529,839  

Note 9. Business Combination.

On December 27, 2011, through its wholly-owned subsidiary, MGPI-I, the Company completed an acquisition of substantially all of the assets used by LDI in its beverage alcohol distillery and warehousing operations.  The Company also assumed certain specified liabilities, primarily consisting of trade payables and customer and contractual obligations.  The purchase price totaled $11,041 for these net assets, which was provided through borrowings under the Company’s revolving line of credit.  The purchase price paid was equal to the current assets minus current liabilities as of December 27, 2011 and is subject to working capital true-ups.

During April 2012, management and the seller completed working capital true-ups.  The result of the true-ups was not material to the Company’s financial results.

Note 10. Assets Held for Sale.

The Company acquired a grain elevator in conjunction with the acquisition of the distillery operations of LDI that was not expected to be used.  This facility and its related assets were reported in current assets as Assets held for sale on the Company’s Condensed Consolidated Balance Sheet as of December 31, 2011.  On March 21, 2012, the Company sold this facility and its related assets for $2,252, resulting in a loss on sale of $48.  Net proceeds after fees and tax prorations totaled $2,232.

 
23

 
Note 11.  Restructuring Cost Activity.

During fiscal 2009, the Company incurred certain restructuring activities, as previously disclosed in Note 9. Restructuring Costs and Loss on Impairment of Assets in Item 8 of Form 10-K for the six month transition period ended December 31, 2011.

Activity related to the severance and early retirement costs was as follows:

   
Quarter Ended
   
Year to Date Ended
   
   
June 30,
 2012
   
June 30,
2011
   
June 30,
2012
   
June 30,
2011
 
Balance at beginning of Period
  $ 194     $ 618     $ 289     $ 791  
Payments and adjustments
    (84 )     (106 )     (179 )     (279 )
Balance at end of period
  $ 110     $ 512     $ 110     $ 512  
 
Activity related to the lease termination restructuring accrual and related costs was as follows:

   
Quarter Ended
   
Year to Date Ended
   
   
June 30,
2012
   
June 30,
2011
   
June 30,
2012
   
June 30,
2011
 
Balance at beginning of Period
  $ 524     $ 1,032     $ 626     $ 1,229  
Provision for additional expense
    176       249       202       249  
Payments and adjustments
    (117 )     (138 )     (245 )     (335 )
Balance at end of period
  $ 583     $ 1,143     $ 583     $ 1,143  



 
24

 
Note 12.  Amendment to Credit Agreement

Effective May 31, 2012, the Company entered into a Fifth Amendment to Credit Agreement (“Fifth Amendment”) with Wells Fargo. The Fifth Amendment modifies the Company’s existing revolving credit facility under the Credit and Security Agreement between the Company and Wells Fargo dated July 21, 2009 (as amended from time to time, the “Credit Agreement”) in several material respects, and summarized as follows:

·  
The definition of “Adjusted Net Income” was amended to mean Net Income, adjusted by excluding from such calculation all cash and non-cash gains, losses, income and expenses related to the following: (a) Equity method investments (though cash gains, losses, income and expenses related thereto shall not be excluded), (b) Swap Contracts and hedging activities, (c) corporate reorganization and restructuring activities or subsidiary start-up operations, and (d) the sale, disposition, purchase or acquisition of assets, other than in the ordinary course of business;

·  
Adjusted Net Income is measured quarterly for the quarters ended June 30, 2012, September 30, 2012 and December 31, 2012.  Thereafter, Adjusted Net Income is based on a rolling 12-month period at the end of each quarterly reporting period;

·  
For the quarters ended June 30, 2012, September 30, 2012 and December 31, 2012, Adjusted Net Income shall not be less than $(1,000), $(500) and $1.00 (one dollar), respectively.   For the 12-month periods thereafter, Adjusted Net Income shall not be less than $1.00 (one dollar);

·  
Fixed Charge Coverage Ratio is measured quarterly on a rolling 12-month period beginning with the 12-month period ending on March 31, 2013, and each quarter thereafter;

·  
Eligible Barreled Alcohol Inventory Advance Rate is a factor applied to Eligible Barreled Alcohol Inventory used in determining Borrowing Base (described below).  For Eligible Barreled Alcohol Inventory that is less than two years old, the factor is 50 percent and for Eligible Barreled Alcohol Inventory that is two years old or greater, the factor is 70 percent; and

·  
The definition of Borrowing Base was amended so that: (a) the sum of the products of Eligible Barreled Alcohol Inventory times the applicable Eligible Barreled Alcohol Inventory Advance Rate included in the Borrowing Base is capped at $7,500, (b) total Rail Inventory included in the Borrowing Base is capped at $3,000, and (c) Distilled Spirits Tax Reserve and Rail Reserve are excluded from the Borrowing Base.

At June 30, 2012, the Company was in compliance with all its debt covenants.  The Company’s debt covenants become more restrictive with regard to reported losses in future periods, and as currently specified, require the Company to report adjusted net earnings, as defined, for periods after September 30, 2012.

 
25

 
ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
(Dollar amounts in thousands, unless otherwise noted)

As used in Management’s Discussion and Analysis, unless the context otherwise requires, the terms “Company,” “we,” or “our” when referenced to after the Reorganization mean MGP Ingredients, Inc. (formerly named MGPI Holdings, Inc.) and its consolidated subsidiaries, and these same terms when referenced prior to the Reorganization mean Processing (formerly named MGP Ingredients, Inc.) and its consolidated subsidiaries.
 
As previously announced, on August 25, 2011 we changed our fiscal year end from June 30 to December 31.  We filed a transition report on Form 10-K with the SEC for the period beginning July 1, 2011 and ending December 31, 2011.  The discussion below compares results for the quarter and year to date periods ended June 30, 2012 to the quarter and six-month to date periods ended June 30, 2011.

The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our unaudited condensed consolidated financial statements and accompanying notes included in this Form 10-Q, as well as our audited consolidated financial statements and accompanying notes and Management’s Discussion and Analysis of Financial Condition and Results of Operations—General, set forth in Items 8 and Item 7, respectively of our Form 10-K for the six-month transition period ended December 31, 2011.

RECENT INITIATIVES
 
Acquisition of the Indiana Distillery

On December 27, 2011, we acquired substantially all the assets used by Lawrenceburg Distillers Indiana, LLC (“LDI”) in its beverage alcohol business, and we now produce premium bourbon, corn and rye whiskeys, gin, grain neutral spirits and distillers feed at our distillery located in Lawrenceburg and Greendale, Indiana (“Indiana Distillery”).  The purchase price of the acquisition was equal to the current assets minus current liabilities as of December 27, 2011, which was estimated at closing to be $11,041.   During April 2012, management and the seller completed working capital true-ups.  The result of the true-ups was not material to our financial results.
 
Since acquiring the distillery operations of LDI, we have taken several steps to improve its profitability.   We recently completed the planning stages of implementing an SAP information technology system for accounting, sales, supply chain and manufacturing at this facility.  We went live on SAP on July 1, 2012.  We have spent $134 on this implementation project through June 30, 2012 and we expect future expenditures to be approximately $280.
 
During the quarter ended March 31, 2012, MGPI-I and the union that covers certain employees at the Indiana Distillery ratified a new multi-year collective bargaining unit agreement, that will terminate December 31, 2017.
 
In conjunction with the acquisition of the distillery operations of LDI, we acquired a grain elevator that was not expected to be used, which was reported as Assets held for sale at December 31, 2011.  On March 21, 2012, we sold this facility and its related assets for $2,252, resulting in a loss of $48.  Net proceeds received, after fees and prorated taxes, totaled $2,232.
 
 
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Ownership change of ICP

On February 1, 2012, Illinois Corn Processing Holdings (“ICP Holdings”), an affiliate of SEACOR Energy, Inc., exercised its option to purchase from us an additional 20 percent of the membership interest in ICP.  The proceeds for this sale approximated $9,103.  Following its exercise, ICP Holdings owns 70 percent of ICP, is entitled to name 4 of ICP’s 6 advisory board members, and generally has control of ICP’s day-to-day operations.  The Company owns 30 percent of ICP and is entitled to name 2 of ICP’s 6 advisory board members.   The transaction resulted in a pre-tax gain of $4,055 during the quarter ended March 31, 2012.

Grain Supply Agreements
 
During the quarter ended March 31, 2012, we entered a grain supply contract for the Indiana Distillery and during the quarter ended June 30, 2012 we extended this agreement for use at our Atchison facility.  The grain supply contracts permit us to purchase corn for delivery up to 12 months in the future, at fixed prices.  The pricing for these contracts is based on a formula using several factors.
 
Supply for commodities has been tight during the first six months of 2012 due, in part, to the drought in the United States.  Market prices for commodities, including corn, have been near historic highs in June 2012, and accordingly, this impacts the pricing we pay under our grain supply agreements.
 
Use of Hedge Accounting
 
Reducing earnings volatility from commodity price swings has long been at the forefront of our risk management strategy, and in early calendar 2011, the Company’s Board of Directors made the decision to adopt hedge accounting.  Effective July 1, 2011, we elected to restart the use of hedge accounting for qualifying derivative contracts entered into on and after July 1, 2011.  For further discussion related to the accounting policy and accounting requirements for our derivative instruments, see Note 1. Accounting Policies and Basis of Presentation - Derivatives and Note 6. Derivative Instruments and Fair Value Measurements set forth in Part I, Item 1.
 
Our utilization of hedge accounting proved to mitigate a portion of our earnings volatility that had been experienced over the few years leading up to the restart of hedge accounting.

In connection with our new grain supply agreements discussed above, we now order corn anywhere from a month to 12 months in the future.  We have determined that the firm commitments to purchase corn under the terms of these new agreements meet the normal purchases and sales exception as defined under ASC 815, Derivative and Hedging, and exclude the fair value of these commitments from recognition in our financial statements until the actual contracts are physically settled.  Accordingly, during the quarter ended March 31, 2012, we de-designated certain cash flow hedges, which resulted in a reclassification of a $27 loss from accumulated other comprehensive income into earnings for the quarter ended March 31, 2012.  As of June 30, 2012, we had no exchange traded corn futures contracts designated as cash flow hedges.  We expect the volume of corn futures and options and the use of hedge accounting to be reduced in the future under our current strategy.

RESULTS OF OPERATIONS
 
Consolidated losses for the quarter ended June 30, 2012 decreased compared to the same period a year ago, with a net loss of $850 on consolidated net sales of $85,534 versus a net loss of $10,258 on consolidated net sales of $68,798 in the quarter ended June 30, 2011.
 
The increase in net sales was primarily the result of our increased sales volume in the distillery products segment.  The loss for the quarter ended June 30, 2012 was driven by higher selling, general and administrative expenses and a 1-week shut-down of the Atchison plant for routine maintenance and general capital project upgrades.

 
27

 
Our improved quarter-over-quarter results were greatly impacted by the loss experienced during the quarter ended June 30, 2011.  Contributing to our loss for the quarter ended June 30, 2011 was a $5,499 unfavorable impact to cost of sales from changes in the fair value of open derivative hedge contracts, a significant portion of which occurred in the last two days of the quarter, high raw material costs, a temporary production interruption, a lag in the adjustment of our alcohol selling prices in step with high corn prices, and low gross margins in our ingredients solutions segment.  The temporary production interruption during the quarter ended June 30, 2011 resulted from a one-week outage related to installing the new distillery water cooling system at the Atchison plant.  This caused production for the month of May 2011 to be below normal.   Our joint venture, ICP, was similarly impacted during the quarter ended June 30, 2011 by high raw material costs and unrealized losses on open commodity derivative contracts as well as a two-week shut-down for maintenance.  ICP experienced a $3,139 net loss for the quarter ended June 30, 2011, of which $1,570 was our 50 percent share.

In our distillery products segment, we achieved both volume and pricing increases compared to the same period a year ago.  In our ingredient solutions segment we experienced a decrease in volume, partially offset by an increase in pricing.  Other segment sales increased slightly.   Pricing in our distillery products and ingredient solutions segments increased whereas the pricing for corn and flour decreased (exclusive of the impact related to the accounting for open commodity contracts), which led to an increase in return on sales in these segments.  In our distillery products segment, return on sales increased from (7.0) percent for the quarter ended June 30, 2011 to 5.3 percent for the quarter ended June 30, 2012.  Our return on sales in our ingredients solutions segment increased from (0.9) percent for the quarter ended June 30, 2011 to 7.0 percent for the quarter ended June 30, 2012.

Consolidated earnings for the year to date period ended June 30, 2012 increased compared to the same period a year ago, with net income of $1,026 on consolidated net sales of $171,878 versus a net loss of $9,557 on consolidated net sales of $132,986 in the year to date period ended June 30, 2011.
 
The increase in net sales was primarily the result of our increased sales volume in the distillery products segment.  Our net income increased for the year to date period primarily due to the quarter-over-quarter increase in earnings for the quarter ended June 30, 2012 described above as well as a $4,055 gain recorded during the quarter ended March 31, 2012 related to the sale of a 20 percent interest in our joint venture, ICP, increased earnings from our joint venture operations and a lower loss on the mark-to-market adjustment for open derivative contracts.  These increases to net income were partially offset by increased general and administrative expenses related to the LDI acquisition and our corporate restructuring.

In our distillery products segment, we achieved both volume and pricing increases compared to the same period a year ago.  In our ingredient solutions segment we experienced a decrease in volume, partially offset by an increase in pricing.  Other segment sales declined slightly.   Pricing in our distillery products segment out-paced the increased costs for corn (exclusive of the impact related to the accounting for open commodity contracts), which led to an increase in return on sales.  In our distillery products segment, return on sales increased from 4.2 percent for the year to date period ended June 30, 2011, to 4.5 percent for the year to date period ended June 30, 2012.  Pricing in our ingredients solutions segment increased whereas the pricing for flour decreased, which led to an increase in return on sales.  Our ingredients solutions segment return on sales increased from (0.1) percent for the year to date period ended June 30, 2011, to 9.5 percent for the year to date period ended June 30, 2012.

 
28

 
NET SALES
 
Net sales for the quarter ended June 30, 2012 increased $16,736, or 24.3 percent, compared to the quarter ended June 30, 2011.  The increase was primarily attributable to increased net sales in the distillery products segment partially offset by decreased net sales in the ingredient solutions segment.  Net sales in the distillery products segment as a whole increased primarily as a result of higher volumes of food grade alcohol, as well as from increased pricing.  Production from our new Indiana Distillery contributed to increased sales of food grade alcohol during the quarter ended June 30, 2012, which we did not own the same period a year ago.  The decrease in net sales in the ingredient solutions segment was due to decreased volume partially offset by improved pricing.  Our other segment experienced a de minimis increase in net sales due to higher volumes partially offset by decreased pricing.
 
Consistent with the second quarter of fiscal 2012, net sales for the year to date period ended June 30, 2012 increased $38,892, or 29.2 percent, compared to the quarter ended June 30, 2011.  The increase was primarily attributable to increased net sales in the distillery products segment partially offset by decreased net sales in the ingredient solutions segment.  Net sales in the distillery products segment as a whole increased primarily as a result of higher volumes of food grade alcohol, as well as from increased prices per unit.  Production from our new Indiana Distillery contributed to increased sales of food grade alcohol during the year to date period ended June 30, 2012, which we did not own the same period a year ago.  The decrease in net sales in the ingredient solutions segment was due to decreased volume partially offset by improved pricing.  Our other segment experienced a de minimis increase in net sales due to slight volume and pricing increases.
 
COST OF SALES
 
For the quarter ended June 30, 2012, cost of sales increased $8,032, or 11.2 percent, compared to the quarter ended June 30, 2011.  For the quarter ended June 30, 2012, cost of sales was 93.1 percent of net sales, which generated a gross profit margin of 6.9 percent.  For the quarter ended June 30, 2011, cost of sales was 104.1 percent of net sales, which generated a negative gross margin of 4.1 percent.
 
Our higher overall costs were primarily the result of production increases related to distillery products.  Production of food grade alcohol from our new Indiana Distillery contributed to the overall increase in cost of sales during the quarter ended June 30, 2012, which we did not own the same period a year ago.  These cost increases were partially offset by a favorable quarter-over-quarter impact related to the accounting for open commodity derivative contracts, lower per-bushel corn prices, per-pound flour prices and natural gas prices.  For the quarter ended June 30, 2012, our open commodity contracts had a $2,002 favorable impact to cost of sales compared to a $5,499 unfavorable impact for the quarter ended June 30, 2011.  We use these contracts to mitigate the impact of changes in commodity prices.  We saw decreases in the per-bushel cost of corn, the per-pound cost of flour (exclusive of the impact related to the accounting for open commodity contracts), and the per-million cubic foot cost of natural gas, which averaged 4.8 percent, 7.8 percent, and 13.0 percent lower, respectively, than the quarter ended June 30, 2011.
 
For the year to date period ended June 30, 2012, cost of sales increased $31,128, or 24.1 percent, compared to the year to date period ended June 30, 2011.  For the year to date period ended June 30, 2012, cost of sales was 93.3 percent of net sales, which generated a gross profit margin of 6.7 percent.  For the year to date period ended June 30, 2011, cost of sales was 97.2 percent of net sales, which generated a gross margin of 2.8 percent.

 
29

 
For the year to date period ended June 30, 2012, our higher overall costs were directly the result of production increases related to distillery products and higher corn prices.   Production of food grade alcohol from our new Indiana Distillery, which we did not own the same period a year ago, contributed to the overall increase in cost of sales during the year to date period ended June 30, 2012.  We saw an increase in the per-bushel cost of corn, which averaged 0.3 percent higher than the year to date period ended June 30, 2011 (exclusive of the impact related to the accounting for open commodity contracts). These cost increases were partially offset by a period-over-period favorable impact related to the accounting for open commodity derivative contracts and lower per-pound flour prices and natural gas prices.  For the year to date period ended June 30, 2012, our open commodity contracts had a $1,001 favorable impact to cost of sales compared to a $3,949 unfavorable impact for the year to date period ended June 30, 2011.  We use these contracts to mitigate the impact of changes in commodity prices. We saw decreases in the per-pound cost of flour and the per-million cubic foot cost of natural gas, which averaged nearly 1.6 percent and 12.4 percent lower, respectively, than the year to date period ended June 30, 2011.
 
For the quarter and year to date periods ended June 30, 2011, hedge accounting was not used as we did not restart our use of hedge accounting until July 1, 2011 (for qualifying derivative contracts entered into on and after July 1, 2011) as further discussed in “- Recent Initiatives” and in Note 1. Accounting Policies and Basis of Presentation set forth in Item I, Financial Statements of this Form 10-Q and incorporated herein by reference.  In connection with the grain supply agreements discussed previously, we de-designated certain cash flow hedges, which resulted in a reclassification of a $27 loss from accumulated other comprehensive income into cost of sales during the quarter ended March 31, 2012.  As of June 30, 2012, we had no derivative contracts designated as cash flow hedges.

SELLING, GENERAL AND ADMINISTRATIVE EXPENSES
 
Selling, general and administrative expenses for the quarter ended June 30, 2012 increased by $1,405, or 28.8 percent, compared to the quarter ended June 30, 2011.  This increase was primarily due to an increase in professional fees, higher personnel costs and long-term incentives, and increased accruals associated with our short-term incentive program.  The higher personnel costs were impacted by our acquisition of LDI’s beverage alcohol business in late 2011.
 
 
Selling, general and administrative expenses for the year to date period ended June 30, 2012 increased by $3,463, or 32.8 percent, compared to the year to date period ended June 30, 2011.  This increase was primarily due to an increase in professional fees, higher personnel costs and long-term incentives, and increased accruals associated with our short-term incentive program.  Professional fees increased primarily due to our corporate reorganization and our acquisition of LDI’s distillery business.  The higher personnel costs were impacted by our acquisition of LDI’s distillery business in late 2011.
 
GAIN ON SALE OF JOINT VENTURE INTEREST

As previously discussed, on February 1, 2012, ICP Holdings exercised its option to purchase from the Company an additional 20 percent of the membership interest in ICP.  The sales price was $9,103 and the transaction resulted in a pre-tax gain of $4,055 for the year to date period ended June 30, 2012.

INTEREST EXPENSE

Interest expense for the quarter and year to date periods ended June 30, 2012 increased $232, and $395, respectively, compared to the same periods ended June 30, 2011.  These increases were primarily the result of higher average daily balance and interest rate on our line of credit as well as higher long term debt compared to the same period a year ago.
 
 
30

 
EQUITY IN EARNINGS (LOSS) OF JOINT VENTURES

ICP

On February 1, 2012, ICP Holdings exercised its option to purchase an additional 20 percent of the membership interest in ICP.  Following its exercise, the Company owns 30 percent of ICP.

 For the quarter ended June 30, 2012, ICP had a loss of $369.  As a 30 percent owner, our portion of the loss was $110.  For the quarter ended June 30, 2011, ICP had a loss of $4,625.  As a 50 percent owner, our portion of the loss was $2,313.

 For the year to date periods ended June 30, 2012, ICP had earnings of $759.  As a 50 percent owner for the month of January 2012 and a 30 percent owner for the months of February through June 2012, our portion of the earnings was $363.  For the year to date periods ended June 30, 2011, ICP had a loss of $4,468.  As a 50 percent owner, our portion of the loss was $2,234.

D.M. Ingredients, GmbH (“DMI”)

On July 17, 2007, we completed a transaction with Crespel and Dieters 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 Crespel and Dieters and third parties, internationally.  We own a 50 percent interest in DMI, and account for it using the equity method of accounting.  As of June 30, 2012, we had invested $571 in DMI since July 2007.

For the quarters ended June 30, 2012 and 2011, DMI had earnings (loss) of $(65) and $34, respectively.  As a 50 percent joint venture holder, our equity in earnings (loss) was $(33) and $17 for the quarters ended June 30, 2012 and 2011, respectively.

For the year to date periods ended June 30, 2012 and 2011, DMI had earnings (loss) of $(137) and $124, respectively.  As a 50 percent joint venture holder, our equity in earnings (loss) was $(69) and $62 for the year to date periods ended June 30, 2012 and 2011, 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.

NET INCOME (LOSS)

As the result of the factors outlined above, we experienced a net income (loss) of $(850) and $1,026 in the quarter and year to date periods ended June 30, 2012, respectively, compared to a net loss of $10,258 and $9,557 in the quarter and year to date periods ended June 30, 2011, respectively.
 
31

 
SEGMENT RESULTS
 
The following is a summary of revenues and pre-tax profits / (loss) allocated to each reportable operating segment for the quarter and year to date periods ended June 30, 2012 and 2011.  For additional information regarding our operating segments, see Note 7. Operating Segments included under Part 1, Item 1, Financial Statements of this Form 10-Q and incorporated herein by reference.
 
   
Quarter Ended
   
Year to Date Ended
 
   
June 30,
2012
   
June 30,
2011
   
June 30,
2012
   
June 30,
2011
 
Distillery products
                       
Net Sales
  $ 71,196     $ 52,965     $ 143,681     $ 103,293  
Pre-Tax Income
    3,762       (3,712 )     6,448       4,294  
Ingredient solutions
                               
Net Sales
    14,090       15,604       27,668       29,178  
Pre-Tax Income
     987       (136 )     2,624        (35 )
Other
                               
Net Sales
    248       229       529       515  
Pre-Tax Loss
    (150 )     (209 )     (246 )     (385 )

DISTILLERY PRODUCTS
 
Total distillery products sales revenue for the quarter ended June 30, 2012 increased $18,230, or 34.4 percent, compared to the quarter ended June 30, 2011.  This increase was primarily attributable to an increase in sales of high quality food grade alcohol of 37.8 percent, which was due to an 18.0 percent increase in per unit pricing as well as a 16.8 percent increase in volume compared to the same period a year ago.  With the recent acquisition of the Indiana Distillery, which we did not own the same period a year ago, we added significant volume to our food grade alcohol sales.  Also contributing to the overall sales increase in the distillery products segment were increases of $2,219 and $552 in distillers feed and warehousing revenue earned at our Indiana Distillery, respectively, for the quarter ended June 30, 2012 compared to the quarter ended June 30, 2011.  Our pricing increased whereas our pricing for corn (exclusive of the impact related to the accounting for open commodity contracts) and natural gas decreased.  For the quarter ended June 30, 2012, the per-bushel cost of corn averaged nearly 4.8 percent lower than the quarter ended June 30, 2011.  Corn prices in of spring of 2011 were negatively impacted by flooding conditions in and around Atchison, Kansas.  The per-million cubic foot cost of natural gas averaged nearly 13.0 percent lower than the same period a year ago.   While overall revenues for distillery products increased for the quarter ended June 30, 2012 as compared to the same quarter a year ago, return on sales increased as previously described in “-General,”, which was primarily driven by a favorable swing in earnings related to the accounting for open commodity contracts.  For the quarter ended June 30, 2012, our open commodity contracts had a $2,002 favorable impact to cost of sales compared to a $5,499 unfavorable impact for the quarter ended June 30, 2011.
 
Consistent with the quarter ended June 30, 2012, total distillery products sales revenue for the year to date period ended June 30, 2012 increased $40,388, or 39.1 percent, compared to the year to date period ended June 30, 2011.  This increase was primarily attributable to an increase in sales of high quality food grade alcohol of 41.0 percent, which was due to a 22.9 percent increase in per unit pricing as well as a 14.8 percent increase in volume compared to the same period a year ago.  With the recent acquisition of the Indiana Distillery, we did not own the same period a year ago, we added significant volume to our food grade alcohol sales.  Also contributing to the overall sales increase in the distillery products segment were increases of $5,943 and $1,177, respectively, in distillers feed and warehousing revenue earned at our Indiana Distillery for the year to date period ended June 30, 2012 compared to the year to date period ended June 30, 2011.  Our pricing out-paced the increased costs for corn (exclusive of the impact related to the accounting for open commodity contracts), while natural gas pricing decreased.  For the year to date period ended June 30, 2012, the per-bushel cost of corn averaged nearly 0.3 percent higher than the year to date period ended June 30, 2011.  On the other hand, the per-million cubic foot cost of natural gas averaged nearly 12.4 percent lower than the same period a year ago. While overall revenues for distillery products increased for the year to date period ended June 30, 2012 as compared to the same year to date period a year ago, return on sales increased as previously described in “-General,”  which was primarily driven by an favorable swing in earnings related to the accounting for open commodity contracts.  For the year to date period ended June 30, 2012, our open commodity contracts had a $1,001 favorable impact to cost of sales compared to a $3,946 unfavorable impact for the year to date period ended June 30, 2011.
 
 
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INGREDIENT SOLUTIONS
 
Total ingredient solutions sales revenue for the quarter ended June 30, 2012 decreased by $1,514, or 9.7 percent, compared to the quarter ended June 30, 2011.  Specialty starches saw a 23.9 percent decrease in revenues compared to the same period a year ago due to a volume decrease partially offset by an increase in per unit pricing.  Revenues for specialty proteins for the quarter ended June 30, 2012 increased 2.1 percent compared to the quarter ended June 30, 2011 due to slight increases in volume and per unit pricing.  Commodity starch saw a 21.1 increase in revenues compared the same period a year ago due to per unit pricing and volume increases.  Revenues for commodity starches and proteins totaled 17.2 percent and 13.1 percent of total segment sales for the quarters ended June 30, 2012 and 2011, respectively.  While we experienced a quarter-over-quarter increase in our commodity products as a percentage of total segment sales, our focus remains on the production and commercialization of specialty ingredients.   Our margins in the ingredient solutions segment saw an increase during the quarter ended June 30, 2012 compared to the quarter ended June 30, 2011.  This was principally due to improved average selling prices, lower natural gas prices and lower raw material costs for flour.  Natural gas prices averaged approximately 13.0 percent lower compared to the quarter ended June 30, 2011.  Flour costs averaged approximately 7.8 percent lower per pound compared to the same period a year ago.
 
Consistent with the quarter ended June 30, 2012, total ingredient solutions sales revenue for the year to date period ended June 30, 2012 decreased by $1,510, or 5.2 percent, compared to the year to date period ended June 30, 2011.  Specialty starches saw a 16.8 percent decrease in revenues compared to the same period a year ago due to a volume decrease partially offset by an increase in per unit pricing.  Revenues for specialty proteins for the year to date period ended June 30, 2012 increased 2.5 percent compared to the year to date period ended June 30, 2011 due to slight increases in volume and per unit pricing.  Commodity starch saw a 20.3 increase in revenues compared the same period a year ago due to per unit pricing and volume increases.  Revenues for commodity starches and proteins totaled 18.0 percent and 14.4 percent of total segment sales for the year to date periods ended June 30, 2012 and 2011, respectively.  While we experienced a period-over-period increase in our commodity products as a percentage of total segment sales, our focus remains on the production and commercialization of specialty ingredients.   Our margins in the ingredient solutions segment saw an increase during the year to date period ended June 30, 2012 compared to the year to date period ended June 30, 2011.  This was principally due to improved average selling prices, lower natural gas prices and lower raw material costs for flour.  Natural gas prices averaged approximately 12.4 percent lower compared to the year to date period ended June 30, 2011.  Flour costs averaged approximately 1.6 percent lower per pound compared to the same period a year ago.
 

 


 
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LIQUIDITY AND CAPITAL RESOURCES

GENERAL

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.  Generally, during periods when commodity prices are rising, our operations require increased use of cash to support inventory acquisition.  Supply for commodities has been even tighter during the first six months of 2012 due to the drought in the United States.  Market prices for commodities, including corn, have been near historic highs in June 2012.  Our principal sources of cash are revenues from the products we make and our revolving credit facility.  We also have used cash for acquisitions, and we have received cash from investment or asset dispositions and tax refunds.
 
On February 1, 2012, we sold a 20 percent interest in ICP to ICP Holdings for $9,103.  The sale resulted when ICP Holdings exercised an option it acquired from the Company when ICP Holdings purchased its existing interest in ICP in 2009.
 
On December 27, 2011, we closed our acquisition of distillery operations of LDI.  The purchase price of the acquisition was equal to the current assets minus current liabilities as of December 27, 2011, which was $11,041.  The purchase price was funded primarily through our bank revolving credit facility and was subject to post-closing adjustments for working capital true-ups, which were finalized during April, 2012 and were not material to our financial results.  Out of the purchase price, escrow accounts aggregating $3,852 were set up to fund working capital true-ups, possible future indemnification claims and COBRA expenses.  During Q2, the working capital true-ups were settled, leaving an escrow balance of $3,300 at June 30, 2012.
 
As we now purchase corn for future delivery under new grain supply agreements, our need for restricted cash has decreased as we have consequently reduced the volume of our open corn futures and options contracts at June 30, 2012.
 
Under agreements that the Company made in March 2011 with a third-party logistics company that contracts with transportation companies, fees for the previous six months are paid in early January and July of each calendar year.  We paid $7,770 for our second billing under this agreement on January 6, 2012 and we paid $6,864 for our third billing under this agreement on July 6, 2012.
 
On March 1, 2012, the Board of Directors declared a five (5) cent dividend per share of Common Stock.    The $914 dividend was paid on April 19, 2012 to common stockholders of record on March 22, 2012.

We have budgeted $7,000 in routine capital expenditures over the twelve-month period ending June 30, 2013 related to other improvements in and replacements of existing plant and equipment and information technology.  As of June 30, 2012, we had contracts to acquire capital assets of approximately $2,439.

We expect our sources of cash to be adequate to provide for budgeted capital expenditures and anticipated operating requirements.
 
 
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The following table is presented as a measure of our liquidity and financial condition:

   
June 30,
   
December 31,
 
   
2012
   
2011
 
Cash and cash equivalents
  $ -     $ 383  
Working capital
    22,493       18,887  
Amounts available under lines of credit
    21,120       23,358  
Credit facility, notes payable and long-term debt
    31,073       29,664  
Stockholders’ equity
    85,062       84,430  

   
Year to Date Ended
 
   
June 30,
   
June 30,
 
   
2012
   
2011
 
Depreciation and amortization
  $ 5,843     $ 4,760  
Capital expenditures
    4,245       9,111  
Cash flows from operations
    (7,468 )     4,123  

CASH FLOW INFORMATION

Summary cash flow information follows for the year to date periods ended June 30, 2012 and 2011:

   
Year to Date Ended
 
   
June 30,
   
June 30,
 
   
2012
   
2011
 
Cash flows provided by (used for):
           
Operating activities
  $ (7,468 )   $ 4,123  
Investing activities
    6,590       (9,111 )
Financing activities
    495       12,119  
                 
Increase (decrease) in cash and cash equivalents
    (383 )     7,131  
Cash and cash equivalents at beginning of year
    383       472  
Cash and cash equivalents at end of period
  $ -     $ 7,603  

During the year to date period ended June 30, 2012, our consolidated cash decreased $383 to $0 as compared to the year to date period ended June 30, 2011, in which there was a $7,131increase in cash.  Decreased operating cash flow resulted primarily from a decrease in accounts payable and accounts payable to affiliate, an increase in receivables and an increase in inventory.  These decreases to operating cash flow were partially offset by a decrease in restricted cash and an increase in net income (after giving effect to a $4,055 deduction related to the non-cash gain on sale of our 20 percent interest in ICP).  Cash outflows related to capital expenditures during the year to date period ended June 30, 2012 decreased compared to the year to date period ended June 30, 2011, while proceeds from the disposition of property and of our 20 percent interest in ICP increased.  During the year to date period ended June 30, 2012, borrowings on debt exceeded payments on debt by $1,409 as compared to the year to date period ended March, 2011, in which borrowings exceeded payments on debt by $11,556.
 
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Operating Cash Flows.  Summary operating cash flow information for the year to date periods ended June 30, 2012 and 2011 is as follows:

   
Year to Date Ended
 
   
June 30,
2012
   
June 30,
2011
 
Cash Flows from Operating Activities
           
Net income (loss)
  $ 1,026     $ (9,557 )
Adjustments to reconcile net income (loss) to net cash provided by operating activities:
               
Depreciation and amortization
    5,843       4,760  
Gain on sale of joint venture interest
    (4,055 )     -  
Loss on sale of assets
    48       -  
Share based compensation
    419       609  
Equity in (earnings) loss of joint ventures
    (294 )     2,172  
Changes in operating assets and liabilities:
               
Restricted cash
    4,848       (538 )
Receivables, net
    (7,560 )     (6,229 )
Inventory
    (5,443 )     3,885  
Prepaid expenses
    (129 )     (90 )
Refundable income taxes
    52       (41 )
Accounts payable
    (998 )     6,133  
Accounts payable to affiliate, net
    (1,556 )     2,404  
Accrued expenses
    1,058       283  
Change in derivatives
    (270 )     -  
Deferred credit
    (299 )     (597 )
Accrued retirement health and life insurance benefits and other noncurrent liabilities
    (158 )     (613 )
Other
    -       1,542  
Net cash provided by (used in)  operating activities
  $ (7,468 )   $ 4,123  

Cash flow from operations for the year to date period ended June 30, 2012 decreased $11,591 to $(7,468) from $4,123 for the year to date period ended June 30, 2011.  This decrease in operating cash flow was primarily the result of a decrease in accounts payable and accounts payable to affiliate, an increase in receivables and an increase in inventory as well as the timing of cash receipts and disbursements.  The increase in sales contributed to the increase in receivables and the acquisition of the Indiana Distillery, which we did not own the same period a year ago, contributed to the increase in inventory.  Accounts payable decreased $998 for year to date period ended June 30, 2012 compared to an increase of $6,133 for the year to date period ended June 30, 2011.  Accounts payable to affiliate decreased $1,556 for year to date period ended June 30, 2012 compared to an increase of $2,404 for the year to date period ended June 30, 2011.  Receivables increased $7,560 for the year to date period ended June 30, 2012 compared to an increase of $6,229 for the year to date period ended June 30, 2011.  Inventory increased $5,443 for the year to date period ended June 30, 2012 compared to a decrease of $3,885 for the year to date period ended June 30, 2011.

The above factors, which served to decrease operating cash flow, were partially offset by the following:
 
·  
increase in net income (after giving effect to a $4,055 deduction related to the non-cash gain on sale of our 20 percent interest in ICP);
·  
for the year to date period ended June 30, 2012, a decrease in restricted cash of $4,848 that was required to be pledged to the broker for our exchange-traded commodity instruments, due to decline in the number of open market positions and the fair market value of our open market positions relative to the respective contract prices.  This compares to a decrease in the pledge requirement of $538 for the year to date period ended June 30, 2011; and
 
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·  
for the year to date period ended June 30, 2012, an increase in accrued expenses of $1,058 compared to an increase of $283 for the year to date period ended June 30, 2011.

Investing Cash Flows.  Net investing cash flow for the year to date period ended June 30, 2012 was $6,590 compared to $(9,111) for the year to date period ended June 30, 2011.  During the year to date period ended June 30, 2012, we made capital investments of $4,245 and we also made a $500 expenditure to fund our portion of the capital improvements at ICP.  During the year to date period ended June 30, 2012, we received proceeds from the disposition of property and equipment of $2,232 that were classified as Assets held for sale at December 31, 2011 and we also received proceeds of $9,103 related to the sale of a 20 interest in ICP.  During the year to date period ended June 30, 2011, we made capital investments of $9,111.
 
Financing Cash Flows.  Net financing cash flow for the year to date period ended June 30, 2012 was $495 compared to $12,119 for the year to date period ended June 30, 2011, for a net decrease in financing cash flow of $11,624.  During the year to date period ended June 30, 2012, we had net borrowings of $2,238 under our operating line of credit compared to net borrowings of $4,572 for the year to date period ended June 30, 2011.  Our payments on long-term debt totaled $829 for the year to date period ended June 30, 2012 compared to net borrowings of $6,984 for the year to date period ended June 30, 2011.

CAPITAL EXPENDITURES
 
For the year to date period ended June 30, 2012, we made $4,982 of capital investments, of which $4,245 was a use of cash and $737 remained payable at June 30, 2012.  The capital investments related primarily to facility improvements and upgrades.  

LINE OF CREDIT
 
On January 3, 2012, we entered into the Assignment and Assumption of Note and Credit Agreement and Fourth Amendment to the Credit Agreement (the “Fourth Amendment”) with Wells Fargo Bank National Association (“Wells Fargo”) pursuant to which we amended the Credit and Security Agreement dated July 21, 2009.  The Fourth Amendment modified the existing revolving credit facility under the Credit Agreement in several material respects, as follows:

·  
In connection with the Reorganization, the Company assumed Processing’s obligations and indebtedness and became the “Borrower” under the Credit Agreement;
·  
Processing released and discharged Wells Fargo from any and all claims related to the Credit Agreement;
·  
The Fourth Amendment provides that Holdings and its more than 50%-held subsidiaries (the “Subsidiaries”), which includes Processing, are deemed to be one consolidated entity and, thus, Holdings and the Subsidiaries are generally subject to the representations and warranties and the covenants in the Credit Agreement as a single, consolidated entity.

On January 3, 2012, Processing also executed a Continuing Guaranty, whereby it agreed to guarantee the obligations of the Company under the Credit Agreement.  Further, on January 3, 2012, Processing executed a Third Party Security Agreement which gives Wells Fargo a security interest in Processing’s assets as security for its obligations under the Continuing Guaranty.

Effective May 31, 2012, we entered into the Assignment and Assumption of Note and Credit Agreement and Fifth Amendment to Credit Agreement (“Fifth Amendment”) with Wells Fargo pursuant to which we amended the Credit and Security Agreement dated July 21, 2009 (as amended, the “Credit Agreement”).  The Fifth Amendment modified the revolving credit facility under the Credit Agreement in several material respects, and summarized as follows:
 
 
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