MGP Ingredients 10-Q 2008
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 2008.
o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
Commission File Number: 0-17196
MGP INGREDIENTS, INC.
(Exact name of registrant as specified in its charter)
(Registrants 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 o 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 definitions of large accelerated filer, accelerated filer, and smaller reporting company in Rule 12b-2 of the Exchange Act. (Check one):
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). o Yes x No
Indicate the number of shares outstanding of each of the issuers classes of common stock, as of the latest practicable date.
Common stock, no par value
16,559,253 shares outstanding
as of March 31, 2008
Audit Committee, Board of Directors and Stockholders
MGP Ingredients, Inc.
We have reviewed the accompanying condensed consolidated balance sheets of MGP Ingredients, Inc. as of March 31, 2008 and April 1, 2007, and the related condensed consolidated statements of income for the three-month and nine-month periods ended March 31, 2008 and April 1, 2007, and cash flows for the nine-month periods ended March 31, 2008 and April 1, 2007. These interim financial statements are the responsibility of the Companys management.
We conducted our reviews in accordance with the standards of the Public Company Accounting Oversight Board (United States). A review of interim financial information consists principally of applying analytical procedures to financial data and making inquiries of persons responsible for financial and accounting matters. It is substantially less in scope than an audit conducted in accordance with the standards of the Public Company Accounting Oversight Board, the objective of which is the expression of an opinion regarding the financial statements taken as a whole. Accordingly, we do not express such an opinion.
Based on our reviews, we are not aware of any material modifications that should be made to the condensed consolidated financial statements referred to above for them to be in conformity with accounting principles generally accepted in the United States of America.
We have previously audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheet as of July 1, 2007 and the related consolidated statements of income, stockholders equity and cash flows for the year then ended (not presented herein); and in our report dated August 31, 2007, we expressed an unqualified opinion on those consolidated financial statements. In our opinion, the information set forth in the accompanying condensed consolidated balance sheet as of July 1, 2007 is fairly stated, in all material respects, in relation to the consolidated balance sheet from which it has been derived.
MGP INGREDIENTS, INC.
See Notes to Condensed Consolidated Financial Statements
MGP INGREDIENTS, INC.
See Notes to Condensed Consolidated Financial Statements
MGP INGREDIENTS, INC.
See Notes to Condensed Consolidated Financial Statements
MGP INGREDIENTS, INC.
Note 1. Basis of Presentation.
The accompanying unaudited condensed consolidated balance sheets of MGP Ingredients, Inc. as of March 31, 2008 and April 1, 2007, condensed consolidated statements of income for the quarter and year-to-date periods ended March 31, 2008 and April 1, 2007 and the condensed consolidated statements of cash flow for the year-to-date periods ended March 28, 2008 and April 1, 2007 reflect all adjustments that are, in the opinion of the Companys management, necessary to fairly present the financial position, results of operations and cash flows of the Company. Except for the $8.1 million impairment loss further discussed in Note 11 and the $2.0 million accounting error correction discussed in Note 12, those adjustments consist only of normal recurring adjustments. The condensed consolidated balance sheet as of July 1, 2007 has been derived from the audited consolidated balance sheet of the Company as of that date. Certain information and note disclosures normally included in the Companys annual financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted. These condensed consolidated financial statements as of and for the period ended March 31, 2008 should be read in conjunction with the consolidated financial statements and notes thereto in the Companys Form 10-K Annual Report for the fiscal year ended July 1, 2007 filed with the Securities and Exchange Commission. The condensed consolidated balance sheet as of April 1, 2007 should be read in conjunction with the consolidated financial statements and notes thereto in the Companys Form 10-K Annual Report for the fiscal year ended June 30, 2006 filed with the Securities and Exchange Commission. The results of operations for the period ended March 31, 2008 are not necessarily indicative of the results to be expected for the full year. Certain prior year amounts have been reclassified to conform to current year presentation.
For the quarter and year-to-date periods ended March 31, 2008 and April 1, 2007, the Company has reclassified other operating income into cost of sales. Following a review of the transactions reported within other operating income, management concluded that it would be more appropriate to reclassify them within cost of sales because they relate to amounts received from transactions involving the sale of by-products or the use of operating assets by third parties which reduce the cost of sales. As a result, for the quarter ended April 1, 2007, cost of sales and gross profit previously reported of $85,517,000 and $8,290,000 respectively (adjusted for restatement), are now reported as $85,720,000 and $8,087,000 respectively. For the year-to-date period ended April 1, 2007, cost of sales and gross profit previously reported of $227,000,000 and $39,447,000 respectively (adjusted for restatement), are now reported as $226,279,000 and $40,168,000 respectively.
The Companys most recently completed fiscal year ended on July 1, 2007. On March 6, 2008 the Board of Directors amended the Companys bylaws to effect a change in the fiscal year. The change will affect the current fiscal year, which was to have expired on June 29, 2008. As a result of the change, the current quarter and fiscal year will end on March 31 and June 30 respectively, and will contain one additional day.
Note 2. Earnings Per Share.
Basic earnings per share data is computed by dividing income available to common shareholders by the weighted average number of common shares outstanding for the period. Potentially dilutive instruments are stock options and unvested restricted stock awards.
The following is a reconciliation from the weighted average shares used for the basic earnings per share computation to the shares used for the diluted earnings per share computation for the quarters and year-to-date periods ended March 31, 2008 and April 1, 2007, respectively.
Note 3. Segment Changes.
In the quarter ended September 30, 2007, the Company expanded the number of operating segments from two to three. Following a review of the Companys business, management concluded that it would be more appropriate and would provide the Companys shareholders with better information if the Company were to include its pet treat resins and plant-based biopolymers in a separate segment. These are now being reported within the other segment (other). The ingredients segment has been re-titled ingredient solutions, to better reflect the Companys integrated approach to providing comprehensive solutions to its ingredient solutions customers. The ingredient solutions segment continues to report vital wheat gluten, commodity starch, specialty proteins and starches as well as mill products, currently consisting of wheat flour and mill feeds sold primarily for agricultural purposes. The distillery products segment continues to report food grade alcohol (consisting of beverage and industrial alcohol), fuel grade alcohol and distillery by-products, currently consisting of distillers grain.
In the quarter ended December 30, 2007, the Company further refined the methodology for assessing identifiable assets and earnings (loss) before income taxes for all segments, resulting in greater allocation to operating segments of identifiable assets and earnings (loss) before income taxes versus non-allocated corporate. Amounts previously disclosed as identifiable assets as of July 1, 2007 and earnings (loss) before income taxes for the quarter and year-to-date periods ended April 1, 2007 reflect this revision.
Note 4. Derivative Instruments.
In connection with the purchase of raw materials, principally corn and wheat, for anticipated operating requirements, the Company enters into readily marketable exchange-traded commodity futures and option contracts to reduce the risk of future grain price increases. Changes in the market value of the Companys futures and option contracts have historically been, and are expected to continue to be, highly effective at offsetting changes in the price of the hedged items. Derivative instruments related to the Companys hedging program are recorded as either assets or liabilities and are measured at fair market value. Consistent with application of hedge accounting under Statement of Financial Accounting Standards No. 133 as amended (SFAS 133), prior to April 1, 2008 changes in the fair market value of the derivative instruments designated as cash flow hedges were recorded either in current earnings or in other comprehensive income, depending on the nature of the hedged transaction. Gains or losses recorded in other comprehensive
income were reclassified into current earnings in the periods in which the hedged items were consumed. Any ineffective portion of a hedged transaction was immediately recognized in current earnings.
Application of hedge accounting under SFAS 133 requires significant resources, recordkeeping and analytical systems. As a result of the rising compliance costs and the complexity related to the application of hedge accounting under SFAS 133, the Companys management has elected to discontinue the use of hedge accounting for all commodity derivative positions effective April 1, 2008. Accordingly, changes in the value of derivatives subsequent to March 31, 2008 will be recorded in cost of sales in the Companys Consolidated Statements of Income. Additionally, certain derivative instruments entered into during the third quarter were not designated as hedges. The change in the market value of these instruments has been recorded in cost of sales in the Companys Consolidated Statements of Income. These instruments were adjusted to market value at March 31, 2008. If these derivatives had been designated for hedge accounting, the Company would have recognized lower net income of $1.5 million (net of tax of $0.8 million), or $0.09 less in earnings per share, as a result of deferred gains and ineffectiveness recognized in the third quarter. As of March 31, 2008, the mark-to-market adjustment included in accumulated other comprehensive income will remain in equity until the forecasted transactions to which the specific hedged positions relate occur. At that time, the accumulated comprehensive income will be reclassified to earnings. Regardless of accounting treatment, the Companys management believes all commodity hedges are economic hedges of the Companys risk exposures.
Note 5. Contingencies.
The Company is a party to various legal proceedings, all of which are of an ordinary, routine nature and incidental to its operations. 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 operations of the Company.
Note 6. Operating Segments.
The Company is a fully integrated producer of ingredient solutions, distillery and other products. Products included within the ingredient solutions segment consist of vital wheat gluten, commodity wheat starch, specialty wheat starches and proteins and mill feeds. Distillery products consist of food grade alcohol (consisting of beverage and industrial alcohol), fuel grade alcohol, commonly known as ethanol, and distillers grain and carbon dioxide, which are by-products of the Companys distillery operations. Other products include pet treat resins and plant-based biopolymers as well as other products. For the quarter and year-to-date periods ended March 31, 2008, revenues from products in the other segment represent less than 2.0 percent of the Companys consolidated revenues.
The operating profit for each segment is based on net sales less identifiable operating expenses. 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.
Note 7. Pension and Post Retirement Benefit Obligations.
Pension Benefits. The Company and its subsidiaries provide defined retirement benefits to certain employees covered under collective bargaining agreements. Under the collective bargaining agreements, the Companys pension funding contributions are a function of the wages paid and are determined as a percentage of wages paid. The funding is divided between the defined benefit plan and a 401(k) plan. It has been managements policy to fund the defined benefit plan first in order to render it adequately funded. Any remaining amounts have been used to fund the 401(k) plan. The collective bargaining agreements allow the pension benefits defined under the agreements to be reduced if the funding as described herein is insufficient to provide for such defined benefits. The Company uses a June 30 measurement date for the plan.
The components of the Net Periodic Benefit Cost for the quarter and year-to-date periods ended March 31, 2008 and April 1, 2007, respectively, are as follows:
The Company made employer contributions of $665,000 for the year-to-date period ended March 31, 2008, all of which were paid in the first quarter of fiscal 2008.
Post Retirement Benefits. The Company and its subsidiaries provide certain post-retirement health care and life benefits to all employees. The liability for such benefits is unfunded. The Company uses a May 31 measurement date for the plan.
The components of the Net Periodic Benefit Cost for the quarter and year-to-date periods ended March 31, 2008 and April 1, 2007, respectively, are as follows:
The Company previously disclosed in its financial statements for the year ended July 1, 2007, 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 fiscal year ended June 30, 2008.
Total employer contributions for the quarter and year-to-date periods ended March 31, 2008 were $49,970 and $195,719 respectively.
The Medicare Prescription Drug Improvement Modernization Act of 2003 (the Act) provides certain drug benefits under Medicare Part D, as well as a federal subsidy to sponsors of retiree health care benefit plans that provide benefits at least actuarially equivalent to Medicare Part D. The Company has been unable to conclude whether the benefits provided under the plan are actuarially equivalent to Medicare Part D. Accordingly, the net periodic post-retirement benefit costs above do not reflect any amount associated with the subsidy.
Note 8. Newly Implemented Management Incentive Programs.
Annual Cash Incentive Plan. Beginning in the 2008 fiscal year, the Company has implemented a new annual cash incentive plan based upon modified economic profit (MEP). MEP equals income from operations, net of taxes, less the product of total capital employed in the business multiplied by the estimated cost of capital, which for purposes of the new program is 11 percent. Total capital represents current assets (excluding cash) less current liabilities plus the book value of property, plant and equipment, plus goodwill and other long-term assets. The Board of Directors approved a five year annual cash incentive plan whereby annual awards are based on improvements in MEP. The Board has established a targeted annual growth rate for MEP (Target) of $3.15 million. Additionally, there is a starting hypothetical bonus pool amount (available pool amount) of $10.5 million, which will amortize in equal increments over five years. Although it is anticipated that the annual growth rate will be the same for each year of the program, the Companys compensation committee may change the targeted growth rate from year-to-year. The compensation committee may also determine whether any non-recurring or extraordinary items will be included in income from operations.
In a year in which the change in MEP from the prior year is positive yet less than the Target amount, participants will receive an incentive payment equal to the change in MEP plus 1/3 of the available pool amount, less the amortized amount. In a year in which the change in MEP from the prior year is positive and also greater than the Target, the amount of MEP in excess of the Target amount will be added to the available pool amount and the incentive payment will equal the Target amount plus 1/3 of the available pool amount, less the amortized amount. In a year in which the change in MEP from the prior year is negative, the available pool amount will be reduced by the amount of the negative change in MEP, not to exceed the Target amount, and the incentive payment, if any, will equal 1/3 of the remaining available pool amount, less the amortized amount. The compensation committee must approve and may adjust any award prior to payment.
Restricted Stock Program. The Company has also implemented a new restricted stock program which will be administered under the Companys 2004 Stock Incentive Plan and under which amounts awarded will be based in part on improvements to MEP. Under the program, subject to the availability of shares under the 2004 Stock Incentive Plan, restricted stock awards will be made each year and generally will be based on a percentage (approximately 85.7 percent) of the increase in MEP over the prior year. However, the maximum grant date market value of the awards made for any year to all participants will be $4.5 million and the minimum grant date market value made in any year to all participants, including years in
which the change in MEP is negative, will be $1.5 million. The actual number of shares issued to all participants will be determined on the date the Committee certifies the increase in MEP for fiscal 2008. Shares awarded will vest in 5 years and will pay dividends during the vesting period. Provisions for forfeiture and accelerated and pro rata vesting generally are similar to those under the guidelines for the Companys outstanding performance accelerated restricted stock awards.
Note 9. Gain on Settlement of Litigation.
On December 27, 2007, the Company settled its two year patent infringement and contract litigation. Under the terms of the settlement, the Company agreed to dismiss its lawsuit with prejudice and was paid $8 million, which was received on December 28, 2007. In connection with the settlement, the Company also granted the other parties in the lawsuit a non-exclusive license under its U.S. Patent No. 5,665,152. For the first and second quarters of Fiscal 2008, the Company incurred professional fees of $568,000 and $386,000 respectively, related to this litigation. These amounts have been netted against the gross proceeds for a net amount of $7,046,000. The Company has recorded the settlement as a separate line item below income from operations. The Company used the proceeds from the settlement to reduce the amount outstanding under its line of credit.
Note 10. FIN 48 Implementation.
FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes an interpretation of FASB Statement No. 109 (FIN 48), clarifies the accounting for uncertainty in income taxes by defining criteria that a tax position on an individual matter must meet before that position is recognized in the financial statements. Additionally, FIN 48 provides guidance on measurement, derecognition, balance sheet classification, interest and penalties, interim period accounting, disclosures and transition.
The Company adopted the provisions of FIN 48 on July 2, 2007. In accordance with the recognition standards established by FIN 48, the Company performed a comprehensive review of potential uncertain tax positions in each jurisdiction in which the Company operates. As a result of the Companys review, the Company adjusted the carrying amount of the liability for unrecognized tax benefits, resulting in a net increase to retained earnings of $59,000. The Companys gross liability for unrecognized tax provision is $1.49 million as of July 2, 2007. The Company has recorded deferred tax assets of $711,000 related to the recording of the liability for unrecognized tax benefits.
In accordance with FIN 48, the Company has elected to treat interest and penalties related to tax liabilities as a component of income tax expense. As of the date of adoption, the Company had $199,000 accrued for the payment of interest, and $11,000 accrued for the payment of penalties, which was included in the $1.49 million unrecognized tax benefit liability discussed above.
The amount of the Companys liability for uncertain tax benefits at July 2, 2007 that would impact the effective tax rate, if recognized, was $783,000.
During the first quarter of fiscal 2008, the Company settled an IRS exam related to its June 30, 2005 and June 30, 2006 tax years. An assessment of $85,000 was paid as a result of this exam. The tax and interest assessed was previously recorded as part of the adoption of FIN 48. In addition, in the third quarter of fiscal 2008, the statute of limitations on the Companys 2003 tax returns lapsed. As a result, the FIN 48 liability, excluding the impact of accrued interest and penalties, decreased by approximately $71,000. The benefit was recorded as a component of income taxes for the quarter.
The statute of limitations for the Companys federal income tax returns is open for fiscal years ending on or after the June 30, 2005. The Company files in the states of Kansas, Illinois and Pennsylvania. The statute of limitations on these state tax returns is open for fiscal years ending on or after June 30, 2005.
Note 11. Loss on Impairment of Assets.
In connection with the preparation of financial statements for the quarter ended March 31, 2008, the Company undertook a review of its long-lived assets contained within its other segment and its ingredient solutions segment in accordance with Statement of Financial Accounting Standards No. 144 Accounting for the Impairment or Disposal of Long-Lived Assets (SFAS No. 144). The review took into account the impact of the rising trend of commodity prices on existing contracts and consumer preferences, anticipated sales to existing customers, the failure of anticipated business to develop, recent decisions to cease R&D activities on pet products and reduce staffing in the pet product area and plans to shift production of certain texturized wheat proteins to third parties. Based upon this review, management estimates that the carrying value of the assets comprising its Kansas City manufacturing facility (KCIT facility) exceeds the estimated realizable fair value of these assets. In accordance with SFAS No. 144, the Company has recorded a non-cash pre-tax charge of $8.1 million for the quarter ended March 31, 2008 related to the impairment of these assets. Of this amount, $4.7 million relates to assets allocated to the Companys other segment and $3.4 million relates to assets allocated to the Companys ingredient solutions segment. The Company is evaluating the strategic alternatives for the plant and equipment at its KCIT facility, which may include their sale.
Note 12. Correction of Accounting Error.
The Condensed Consolidated Statements of Income for the quarter and year-to-date periods ended April 1, 2007, Condensed Consolidated Balance Sheets as of April 1, 2007 and July 1, 2007 and the Condensed Consolidated Statement of Cash Flow for the year-to-date period ended April 1, 2007, presented herein have been restated to correct the following error, in accordance with Statement of Financial Accounting Standards No. 154, Accounting Changes and Error Corrections (SFAS 154). Since fiscal 2001, the Company over recognized deferred income from funds that it received over the course of fiscal years 2001 to 2003 under a Commodity Credit Corporation program implemented by Congress following termination of import quotas on gluten. The Company received a total of $26 million under the program, of which approximately $17.5 million was used for capital expenditures. Recognition of the amount used for these capital items was deferred and is being recognized over the life of the assets. The amount recognized each year was to have approximated the amount of depreciation on the assets that the Company acquired under the program. The Company has determined that, through errors made at the offset and throughout execution of the program that were undetected until recently, certain assets were placed on, or omitted from, the depreciation schedule for commodity credit corporation funded assets. As a result of the error, the asset pool whose depreciation determined the amount of deferred credit that was amortized each year and recognized as income had assets whose original cost was $21 million instead of $17.5 million, and as a result, the company recognized excess deferred income in each of fiscal years 2001 through the second quarter of the current fiscal year. The amount of revenue involved ranged annually from a high of $397,000 in 2002 to $175,000 in the current year, resulting in annual overstatements of net income after taxes ranging from a low of 1% to a high of 4.4% through fiscal 2007. The cumulative effect of the error on retained earnings as of March 31, 2008 was $1.2 million on a pre-tax adjustment of $2.0 million.
The Company has conducted a materiality analysis under SAB 108 and determined that the impact on prior years was not material. However, it is required to report the error as an adjustment to its prior period financial statements. The condensed consolidated statements of income for the quarter and year-to-date periods ended April 1, 2007, the balance sheets as of April 1, 2007 and July 1, 2007 and the
condensed consolidated statement of cash flows for the nine months ended April 1, 2007 included in this report have been adjusted to reflect a correction of the period-specific effects of the error and the effect of the correction on each financial statement line item and per share amounts is shown below. The cumulative effect of the error on retained earnings as of the beginning of the year-to-date period ended April 1, 2007 was $1.0 million and the effect on net income for the fiscal year immediately prior thereto (FY 2006) was $124,000.
An analysis of the adjustment to the Condensed Consolidated Statement of Income for the Quarter ended April 1, 2007 is as follows: (In thousands)
An analysis of the adjustment to the Condensed Consolidated Statement of Income for the Year-to-Date ended April 1, 2007 is as follows: (In thousands)
An analysis of the adjustment to the Condensed Consolidated Balance Sheet as of July 1, 2007 is as follows: (In thousands)
An analysis of the adjustment to the Condensed Consolidated Balance Sheet as of April 1, 2007 is as follows: (In thousands)
An analysis of the adjustment to the Condensed Consolidated Statement of Cash Flows for the Year-to-Date ended April 1, 2007 is as follows: (In thousands)
Note 13. Subsequent Events: New Credit Agreement.
On May 5, 2008, the Company entered into a new, secured Credit Agreement with Commerce Bank, N.A., as agent, and Commerce Bank, N.A., BMO Capital Markets Financing, Inc. and National City Bank, as lenders. The Credit Agreement replaces the Companys old line of credit agreement with Commerce Bank, N.A. and, subject to borrowing base limits, provides for a $40 million, three year revolving credit facility and a $25 million, five year, term loan facility. The Credit Agreement contains accordion features which permit the lenders, in their sole discretion, to agree to a one time increase in the revolving credit commitment of up to $20 million and a one-time term loan increase of up to $10 million. The revolving credit commitment contains letter of credit subcommitments of up to $8 million and swingline loan subcommitments (which must be repaid within five business days) of up to $5 million. Borrowings under the term loan facility may be made until May 4, 2009 and the then outstanding principal of the term loan will be payable commencing June 30, 2009 in quarterly payments equal to 1/28 of the then outstanding principal balance of the term loan, with any unpaid principal amount being due on May 5, 2013. The outstanding principal balance of the revolving credit loans is due on May 5, 2011.
Borrowings on base rate loans under the Credit Agreement bear interest, payable monthly, at a rate equal to Commerce Banks prime rate as in effect from time to time, less an applicable margin ranging from (a) 0% if the leverage ratio, as defined below, is greater than or equal to 2.50 to 1, to (b) .75%, if the leverage ratio is less than 1.0 to 1. Borrowings on libor loans bear interest, payable at the end of the applicable interest period (but in any event at the end of each three month portion of a six month libor loan), at a rate equal to the applicable libor rate plus an applicable margin ranging from (a) 2.0%, if the leverage ratio is greater than or equal to 2.50 to 1, to (b) 1.25%, if the leverage ratio is less than 1.0 to 1. Letter of credit fees are payable quarterly and are equal to the applicable margin on libor loans times the lenders exposure under outstanding letters of credit. There is a quarterly non-use fee equal to the sum of, for each day during the preceding calendar quarter, the amount obtained by multiplying (a) the unused amount of the revolving credit commitment for such day, times (b) the applicable margin for non-use fee [.30% if the leverage ratio is greater than or equal to 1.75 to 1 and .25% if the leverage ratio is less than 1.75 to 1], times (c) the fraction, 1/360.
The availability of loans under the Credit Agreement is based on the borrowing base, as defined, which consists of varying percentages of the Companys eligible inventory and accounts receivable, as defined. Borrowings under the Credit Agreement are secured by the Companys accounts and inventory, any related instruments or chattel paper and any equipment that it might refinance with proceeds of the loan.
The Credit Agreement contains various covenants, including ones limiting the Companys ability to incur liens, incur debt, make investments, make capital expenditures, dispose of assets, issue stock, pay dividends outside of the ordinary course or purchase stock. The Credit Agreement also requires the Company to maintain a fixed charge coverage ratio and a leverage ratio and minimum working capital and tangible net worth.
This section 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 and or the negatives of these terms or variations of them or similar terminology. They reflect managements current beliefs and estimates of future economic circumstances, industry conditions, Company performance and financial results and are not guarantees of future performance. All such forward-looking statements are subject to certain risks and uncertainties that could cause actual results to differ materially from those contemplated by the relevant forward-looking statement. Important factors that could cause actual results to differ materially from our expectations include, among others: (i) the availability and cost of grain, (ii) fluctuations in gasoline prices, (iii) fluctuations in energy costs, (iv) competitive environment and related market conditions, (v) our ability to realize operating efficiencies, (vi) the effectiveness of our hedging programs, (vii) access to capital and (viii) actions of governments. 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 fiscal year ended July 1, 2007.
RESULTS OF OPERATIONS
Reference is made to Managements Discussion and Analysis of Financial Condition and Results of OperationsGeneral, incorporated by reference to Item 7 of our Annual Report on Form 10-K for the fiscal year ended July 1, 2007 for certain general information about our principal products and costs.
Critical Accounting Policies and Estimates
Reference is made to Managements Discussion and Analysis of Financial Condition and Results of OperationsCritical Accounting Policies, incorporated by reference to Item 7 of our Annual Report on Form 10-K for the fiscal year ended July 1, 2007, for a discussion of our critical accounting policies and the use of certain judgments and estimates in the preparation of our financial statements.
Impairment of Long-Lived Assets. As previously reported, we review long-lived assets, mainly equipment, if events or circumstances indicate that usage may be limited and carrying values may not be recoverable. Should events indicate the assets cannot be used as planned, the realization from alternative uses or disposal is compared to the carrying value. If an impairment loss is measured, this estimate is recognized. A significant change in the assumptions could result in a different determination of impairment loss and/or the amount of any impairment.
In making such assessments, management must make estimates and judgments relating to anticipated revenues and expenses and values of our assets and liabilities. Managements estimates and judgments are based on our historical experience and managements knowledge and understanding of current facts and circumstances. Management derives data for its estimates from outside and internal sources, and
considers such matters as product mix, unit sales, unit prices, input costs, expected target volume levels in supply contracts and expectations about new customers as well as overall market trends.
We assessed our ingredient solutions and other segments for impairment in both June and December of 2007 and concluded at those times that no impairment was necessary. In reaching our conclusions, we did not anticipate the extent of the downturn in the economy and made some assumptions about trends of commodity prices and expected sales to existing and anticipated customers for our pet products that have proved to be incorrect. Based on a reassessment of these segments following the end of the third quarter, we concluded that the current trend of high commodity prices may continue for the foreseeable future and that our customer base for pet products is migrating away from our wheat based protein resin to a less expensive corn starch basis. We also considered our plans to shift production of certain texturized wheat proteins to third parties. As a result, we concluded that our pet treat assets in our other segment and certain of our ingredient solutions segment assets in a mixed use facility at which our pet treat resins are made were impaired. We are currently reviewing strategic options for this facility, including possible sale.
In measuring for impairment of these assets, we assumed disposition and considered whether their carrying amounts exceed the sum of the undiscounted cash flows that we expect to result from their use and ultimate disposition at fair value. We have estimated that disposition will occur within one year. In estimating the amount of net disposition proceeds, we have accorded equal probability to the possibilities that the assets would be sold as a whole or piecemeal. Our estimates of fair value have been based on third party valuations of some assets and our estimates of the fair value of other assets, which are based on our knowledge of sales of similar assets by others. The discount rate used in determining the present value of the estimated future cash flows was 0 %. Based on the foregoing, we estimated the possible range of loss at between $6.2 million to $10.0 million, and based on our probability analysis we have recorded an impairment charge of $8.1 million. However, there is considerable management judgment necessary to determine the future cash flows and fair value. Further, the amount derived from a disposition can vary significantly depending on the timing and manner of sale. Accordingly, actual results could vary significantly from our estimates.
CHANGES IN SEGMENT REPORTING
In the quarter ended September 30, 2007, we expanded the number of our operating segments from two to three. Following a review of our business, we concluded that it would be more appropriate and would provide our shareholders with better information if we were to include our pet treat resins and plant-based biopolymers in a separate segment. These are now reported within the other segment (other). The ingredients segment has been re-titled ingredient solutions, to better reflect our integrated approach to providing comprehensive solutions to our ingredient solutions customers. The ingredient solutions segment continues to report vital wheat gluten, commodity starch, specialty proteins and starches as well as mill products, currently consisting of wheat flour and mill feeds primarily sold for agricultural purposes. The distillery products segment continues to report food grade alcohol (consisting of beverage and industrial alcohol), fuel grade alcohol and distillery by-products, currently consisting of distillers grain.
For the quarter ended December 30, 2007, we further refined the methodology for assessing identifiable assets and earnings (loss) before income taxes for all segments resulting in greater allocation to operating segments of identifiable assets and earnings (loss) before income taxes versus non-allocated corporate. Amounts previously disclosed as identifiable assets as of July 1, 2007 and earnings (loss) before income taxes for the quarter and year-to-date periods ended April 1, 2007 have been adjusted to reflect this revision.