Ingredion Inc - Quarter Report: 2015 September (Form 10-Q)

 

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 September 30, 2015

 

or

 

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

 

For the transition period from                              to                              

 

COMMISSION FILE NUMBER 1-13397

 

Ingredion Incorporated

(Exact name of Registrant as specified in its charter)

 

DELAWARE

(State or other jurisdiction of incorporation or organization)

 

22-3514823

(I.R.S. Employer Identification Number)

 

 

(708) 551-2600

(Registrant’s telephone number, including area code)

 

 

(Former name, former address and former fiscal year, if changed since last report)

 

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes x  No  o

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).

Yes x  No  o

 

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

 

 

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

 

Indicate the number of shares outstanding of each of the registrant’s classes of common stock, as of the latest practicable date.

 

CLASS		OUTSTANDING AT October 29, 2015
Common Stock, $.01 par value		71,545,000 shares

 

 

 

PART I FINANCIAL INFORMATION

 

ITEM 1

 

FINANCIAL STATEMENTS

 

Ingredion Incorporated (“Ingredion”)

Condensed Consolidated Statements of Income

(Unaudited)

 

		Three Months Ended September 30,						Nine Months Ended September 30,
(In millions, except per share amounts)		2015			2014			2015			2014
Net sales before shipping and handling costs		$	1,524.0		$	1,544.8		$	4,469.6		$	4,547.8
Less: shipping and handling costs		87.3			84.5			253.8			247.7
Net sales		1,436.7			1,460.3			4,215.8			4,300.1
Cost of sales		1,106.8			1,162.7			3,286.6			3,456.8
Gross profit		329.9			297.6			929.2			843.3
Operating expenses		139.2			129.1			415.5			398.6
Other (income) expense, net		1.9			(9.6		)	2.5			(18.4		)
Impairment/restructuring charges		13.8			—			24.2			—
Operating income		175.0			178.1			487.0			463.1
Financing costs, net		13.8			15.1			44.2			49.0
Income before income taxes		161.2			163.0			442.8			414.1
Provision for income taxes		51.2			42.6			138.3			113.9
Net income		110.0			120.4			304.5			300.2
Less: Net income attributable to non-controlling interests		2.1			1.8			6.3			6.4
Net income attributable to Ingredion		$	107.9		$	118.6		$	298.2		$	293.8
Weighted average common shares outstanding:
Basic		71.6			73.0			71.6			74.2
Diluted		72.9			74.3			72.9			75.5
Earnings per common share of Ingredion:
Basic		$	1.51		$	1.62		$	4.17		$	3.96
Diluted		$	1.48		$	1.60		$	4.09		$	3.89

 

See Notes to Condensed Consolidated Financial Statements

 

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PART I FINANCIAL INFORMATION

 

ITEM 1

FINANCIAL STATEMENTS

 

Ingredion Incorporated (“Ingredion”)

Condensed Consolidated Statements of Comprehensive Income (Loss)

(Unaudited)

 

		Three Months Ended						Nine Months Ended
		September 30,						September 30,
(In millions)		2015			2014			2015			2014
Net income		$	110		$	120		$	305		$	300
Other comprehensive income (loss):
Losses on cash-flow hedges, net of income tax effect of $7, $23, $8 and $21, respectively		(15		)	(48		)	(18		)	(47		)
Amount of losses on cash-flow hedges reclassified to earnings, net of income tax effect of $3, $5, $10 and $11, respectively		7			11			23			24
Actuarial gains on pension and postretirement obligations, settlements and plan amendments, net of income tax effect of $2		—			—			6			—
Losses related to pension and other postretirement obligations reclassified to earnings, net of income tax effect		—			1			1			3
Currency translation adjustment		(157		)	(121		)	(283		)	(116		)
Comprehensive income (loss)		(55		)	(37		)	34			164
Comprehensive income attributable to non-controlling interests		(2		)	(2		)	(6		)	(6		)
Comprehensive income (loss) attributable to Ingredion		$	(57	)	$	(39	)	$	28		$	158

 

See Notes to Condensed Consolidated Financial Statements

 

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PART I FINANCIAL INFORMATION

 

ITEM I - FINANCIAL STATEMENTS

 

Ingredion Incorporated (“Ingredion”)

Condensed Consolidated Balance Sheets

 

(In millions, except share and per share amounts)		September 30, 2015			December 31, 2014
		(Unaudited)
Assets
Current assets
Cash and cash equivalents		$	722		$	580
Short-term investments		9			34
Accounts receivable — net		779			762
Inventories		718			699
Prepaid expenses		25			21
Deferred income taxes		39			48
Total current assets		2,292			2,144
Property, plant and equipment - net of accumulated depreciation of $2,737 and $2,813, respectively		2,002			2,073
Goodwill		601			478
Other intangible assets - net of accumulated amortization of $76 and $62, respectively		417			290
Deferred income taxes		4			4
Other assets		128			102
Total assets		$	5,444		$	5,091
Liabilities and equity
Current liabilities
Short-term borrowings		$	24		$	23
Accounts payable and accrued liabilities		646			698
Total current liabilities		670			721
Non-current liabilities		182			157
Long-term debt		2,243			1,804
Deferred income taxes		181			180
Share-based payments subject to redemption		21			22
Equity
Ingredion Stockholders’ equity:
Preferred stock — authorized 25,000,000 shares-$0.01 par value — none issued		—			—
Common stock — authorized 200,000,000 shares-$0.01 par value — 77,810,875 shares issued at September 30, 2015 and December 31, 2014		1			1
Additional paid-in capital		1,160			1,164
Less: Treasury stock (common stock; 6,302,515 and 6,488,605 shares at September 30, 2015 and December 31, 2014, respectively) at cost		(475		)	(481		)
Accumulated other comprehensive loss		(1,053		)	(782		)
Retained earnings		2,481			2,275
Total Ingredion stockholders’ equity		2,114			2,177
Non-controlling interests		33			30
Total equity		2,147			2,207
Total liabilities and equity		$	5,444		$	5,091

 

See Notes to Condensed Consolidated Financial Statements

 

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PART I FINANCIAL INFORMATION

 

ITEM 1

FINANCIAL STATEMENTS

 

Ingredion Incorporated (“Ingredion”)

Condensed Consolidated Statements of Equity and Redeemable Equity

(Unaudited)

 

		Total Equity																		Share-based
(in millions)		Common Stock			Additional Paid-In Capital			Treasury Stock			Accumulated Other Comprehensive Income (Loss)			Retained Earnings			Non- controlling Interests			Payments Subject to Redemption
Balance, December 31, 2014		$	1		$	1,164		$	(481	)	$	(782	)	$	2,275		$	30		$	22
Net income attributable to Ingredion														298
Net income attributable to non-controlling interests																	6
Dividends declared														(92		)	(3		)
Losses on cash-flow hedges, net of income tax effect of $8											(18		)
Amount of losses on cash-flow hedges reclassified to earnings, net of income tax effect of $10											23
Repurchases of common stock					(6		)	(34		)
Issuance of common stock on exercise of stock options					(12		)	30
Share-based compensation					14			10												(1		)
Actuarial gains on pension and postretirement obligations, settlements, and plan amendments, net of income tax effect of $2											6
Losses related to pension and other postretirement obligations reclassified to earnings, net of income tax effect											1
Currency translation adjustment											(283		)
Balance, September 30, 2015		$	1		$	1,160		$	(475	)	$	(1,053	)	$	2,481		$	33		$	21

 

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		Total Equity																		Share-based
(in millions)		Common Stock			Additional Paid-In Capital			Treasury Stock			Accumulated Other Comprehensive Income (Loss)			Retained Earnings			Non- controlling Interests			Payments Subject to Redemption
Balance, December 31, 2013		$	1		$	1,166		$	(225	)	$	(583	)	$	2,045		$	25		$	24
Net income attributable to Ingredion														294
Net income attributable to non-controlling interests																	6
Dividends declared														(94		)	(3		)
Losses on cash-flow hedges, net of income tax effect of $21											(47		)
Amount of losses on cash-flow hedges reclassified to earnings, net of income tax effect of $11											24
Repurchases of common stock					(63		)	(241		)
Issuance of common stock on exercise of stock options					(16		)	33
Share-based compensation					20			2												(4		)
Losses related to pension and other postretirement obligations reclassified to earnings, net of income tax effect											3
Currency translation adjustment											(116		)
Balance, September 30, 2014		$	1		$	1,107		$	(431	)	$	(719	)	$	2,245		$	28		$	20

 

See Notes to Condensed Consolidated Financial Statements

 

6

 

PART I FINANCIAL INFORMATION

 

ITEM 1

FINANCIAL STATEMENTS

 

Ingredion Incorporated (“Ingredion”)

Condensed Consolidated Statements of Cash Flows

(Unaudited)

 

		Nine Months Ended September 30,
(In millions)		2015			2014
Cash provided by operating activities:
Net income		$	305		$	300
Non-cash charges to net income:
Depreciation and amortization		145			147
Write-off of impaired assets		10			—
Charge for fair value mark-up of acquired inventory		8			—
Other		72			49
Changes in working capital:
Accounts receivable and prepaid items		(40		)	(19		)
Inventories		21			(15		)
Accounts payable and accrued liabilities		(40		)	8
Increase in margin accounts		(7		)	(11		)
Other		7			3
Cash provided by operating activities		481			462
Cash used for investing activities:
Payments for acquisitions, net of cash acquired of $16		(434		)	—
Capital expenditures, net of proceeds on disposals		(193		)	(187		)
Short-term investments		24			(1		)
Proceeds from sale of investment		—			11
Cash used for investing activities		(603		)	(177		)
Cash used for financing activities:
Proceeds from borrowings		997			227
Payments on debt		(558		)	(118		)
Repurchases of common stock		(40		)	(304		)
Issuance of common stock		18			17
Dividends paid (including to non-controlling interests)		(94		)	(97		)
Excess tax benefit on share-based compensation		6			5
Cash provided by (used for) financing activities		329			(270		)
Effect of foreign exchange rate changes on cash		(65		)	(24		)
Increase (decrease) in cash and cash equivalents		142			(9		)
Cash and cash equivalents, beginning of period		580			574
Cash and cash equivalents, end of period		$	722		$	565

 

See Notes to Condensed Consolidated Financial Statements

 

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INGREDION INCORPORATED (“Ingredion”)

Notes to Condensed Consolidated Financial Statements

 

1.                                      Interim Financial Statements

 

References to the “Company” are to Ingredion Incorporated (“Ingredion”) and its consolidated subsidiaries.  These statements should be read in conjunction with the consolidated financial statements and the related notes to those statements contained in the Company’s Annual Report on Form 10-K for the year ended December 31, 2014.

 

The unaudited condensed consolidated interim financial statements included herein were prepared by management on the same basis as the Company’s audited consolidated financial statements for the year ended December 31, 2014 and reflect all adjustments (consisting solely of normal recurring items unless otherwise noted) which are, in the opinion of management, necessary for the fair presentation of results of operations and cash flows for the interim periods ended September 30, 2015 and 2014, and the financial position of the Company as of September 30, 2015.  The results for the interim periods are not necessarily indicative of the results expected for the full years.

 

2.                                      New Accounting Standards

 

In May 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2014-09, Revenue from Contracts with Customers (Topic 606) that introduces a new five-step revenue recognition model in which an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services.  This ASU also requires disclosures sufficient to enable users to understand the nature, amount, timing, and uncertainty of revenue and cash flows arising from contracts with customers, including qualitative and quantitative disclosures about contracts with customers, significant judgments and changes in judgments, and assets recognized from the costs to obtain or fulfill a contract.  This standard is effective for fiscal years beginning after December 15, 2017, including interim periods within that reporting period.  The standard will allow various transition approaches upon adoption.  The Company is assessing the impacts of this new standard; however, the adoption of the guidance in this Update is not expected to have a material impact on the Company’s Condensed Consolidated Financial Statements.

 

In April 2015, the FASB issued ASU No. 2015-03, Interest-Imputation of Interest (Subtopic 835-30), for the purpose of simplifying the presentation of debt issuance costs.  This standard requires that debt issuance costs associated with a recognized debt liability be presented in the balance sheet as a direct reduction from the carrying amount of that debt in the balance sheet, consistent with the recording of debt discounts.  The amendments in this Update are effective for financial statements issued for fiscal years beginning after December 15, 2015, and interim periods within those fiscal years and require an entity to apply the guidance on a retrospective basis.  Early adoption of the amendments in this Update is permitted for financial statements that have not been previously issued.  The Company intends to adopt the amendments of the Update in the fourth quarter of 2015.  The adoption of the guidance in this Update is not expected to have a material impact on the Company’s Condensed Consolidated Financial Statements.

 

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In July 2015, the FASB issued ASU No. 2015-11, Inventory (Topic 330): Simplifying the Measurement of Inventory.  This Update requires an entity to measure inventory at the lower of cost and net realizable value, removing the consideration of current replacement cost.  It is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2016, with early adoption permitted.  The Company does not expect that the adoption of the guidance in this Update will have a material impact on the Company’s Condensed Consolidated Financial Statements.

 

In September 2015, the FASB issued ASU No. 2015-16, Business Combinations (Topic 805): Simplifying the Accounting for Measurement — Period Adjustments.  This Update requires an entity to present separately on the face of the income statement or disclose in the notes the portion of the amount recorded in current-period earnings by line item that would have been recorded in previous reporting periods if the adjustment to the provisional amounts had been recognized as of the acquisition date.  The amendments in this Update are effective for fiscal years beginning after December 15, 2015, including interim periods within those fiscal years. The amendments should be applied prospectively to adjustments to provisional amounts that occur after the effective date of this Update with earlier application permitted for financial statements that have not been issued.  The Company adopted the amendments of this Update in the third quarter of 2015.  The adoption of the guidance in this Update did not have a material impact on the Company’s Condensed Consolidated Financial Statements.

 

3.                                      Acquisitions

 

On March 11, 2015, the Company completed its acquisition of Penford Corporation (“Penford”), a manufacturer of specialty starches that was headquartered in Centennial, Colorado. Total purchase consideration for Penford was $332 million, which included the extinguishment of $93 million in debt in conjunction with the acquisition.  The acquisition of Penford provides the Company with, among other things, an expanded specialty ingredient product portfolio consisting of potato starch-based offerings.  Penford had net sales of $444 million for the fiscal year ended August 31, 2014 and operates six manufacturing facilities in the United States, all of which manufacture specialty starches.

 

On August 3, 2015, the Company completed its acquisition of Kerr Concentrates, Inc. (“Kerr”), a privately held producer of natural fruit and vegetable concentrates for approximately $102 million in cash, subject to certain post-closing adjustments.  Kerr employs approximately 80 people and serves major food and beverage companies, flavor houses and ingredient producers from its manufacturing locations in Oregon and California.  The acquisition of Kerr provides the Company with the opportunity to expand its product portfolio.

 

The Company funded these acquisitions with proceeds from borrowings under its revolving credit agreement.  The results of the acquired operations are included in the Company’s consolidated results from the respective acquisition dates forward within the North America business segment.  With these acquisitions, the Company now employs approximately 11,900 people world-wide.

 

For the Penford acquisition, the Company has finalized the purchase price allocation for all areas with the exception of income taxes.  The finalization of the valuation of tangible and intangible assets and liabilities did not have a significant impact on previously estimated amounts.  The Company expects to finalize the purchase price allocation for Penford in the fourth quarter of 2015.  For the Kerr acquisition,  a preliminary allocation of the purchase price to the assets acquired and liabilities assumed was made based on available information and

 

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incorporating management’s best estimates.  Assets acquired and liabilities assumed in the transactions were generally recorded at their estimated acquisition date fair values, while transaction costs associated with the acquisition were expensed as incurred.  The Company is currently in the process of finalizing the valuation of the assets acquired and liabilities assumed related to this acquisition, primarily related to the valuation of tangible and identifiable intangible assets acquired.  As such, the actual allocation of the final purchase price and the resulting effect on net income may differ from the preliminary amounts included herein.  The Company expects to finalize the purchase price allocation for Kerr in the fourth quarter of 2015.

 

Goodwill represents the amount by which the purchase price exceeds the estimated fair value of the net assets acquired.  Goodwill related to the Penford acquisition is not tax deductible for the Company.  The goodwill related to Kerr is tax deductible due to the structure of this acquisition.  The preliminary goodwill of $119 million for Penford and $27 million for Kerr result from synergies and other operational benefits expected to be derived from the acquisitions.

 

The following table summarizes the preliminary purchase price allocations for Penford and Kerr as of March 11, 2015 and August 3, 2015, respectively, for the acquisitions:

 

(in millions)		Penford			Kerr
Working capital (excluding cash)		$	68		$	38
Property, plant and equipment		86			8
Other assets		9			—
Identifiable intangible assets		121			29
Goodwill		119			27
Non-current liabilities assumed		(71		)	—
Total preliminary purchase price		$	332		$	102

 

The identifiable intangible assets for the Penford acquisition include items such as customer relationships, proprietary technology, trade names, and noncompetition agreements. The fair values of these intangible assets were determined to be Level 3 under the fair value hierarchy.  Level 3 inputs are unobservable inputs for an asset or liability.  Unobservable inputs are used to measure fair value to the extent that observable inputs are not available, thereby allowing for situations in which there is little, if any, market activity for an asset or liability at the measurement date.  The following table presents the fair values, valuation techniques, and estimated remaining useful life for these Level 3 measurements (dollars in millions):

 

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							Estimated Remaining
		Fair Value			Valuation Technique		Useful Life
Customer Relationships		$	84		Multi-period excess earnings method		15 - 22 years
Trade names		$	17		Relief-from-royalty method		10 years to indefinite
Technology		$	17		Relief-from-royalty method		6 - 11 years
Noncompetition Agreements		$	3		Income Approach		2 years

 

The fair value of customer relationships, trade names, technology and noncompetition were determined through the valuation techniques described above using various judgmental assumptions such as discount rates and customer attrition rates.

 

The fair values of property, plant and equipment associated with the Penford acquisition was determined to be Level 3 under the fair value hierarchy. Property, plant and equipment values were estimated using either the cost or market approach.

 

Included in the results of the acquired businesses for the three and nine months ended September 30, 2015 were increases in cost of sales of $2 million (Kerr) and $8 million (Penford for $6 million and Kerr for $2 million), respectively, relating to the sale of inventory that was adjusted to fair value at the acquisition dates in accordance with business combination accounting rules.

 

The Company also incurred $2 million and $9 million of pre-tax acquisition and integration costs for the three and nine months ended September 30, 2015, respectively, associated with the Penford and Kerr transactions.

 

4.                                      Sale of Canadian Plant

 

On July 7, 2015, the Company entered into a definitive agreement to sell its manufacturing assets in Port Colborne, Ontario, Canada for approximately $30 million.  The sale is expected to close in the fourth quarter of 2015 and is currently expected to result in a pre-tax gain of approximately $10 million in that quarter.  In the third quarter of 2015, the Company recorded a pre-tax restructuring charge of $2 million associated with the sale of the plant as described below.  Additionally, the Company could incur pension-related charges in the first half of 2016 related to the plant sale.  Such charges, if any, are not expected to be significant.

 

5.                                      Impairment and Restructuring Charges

 

On September 8, 2015, the Company announced that it plans to consolidate its manufacturing network in Brazil.  Plants in Trombudo Central and Conchal will be closed and production will be moved to plants in Balsa Nova and Mogi Guaçu, respectively.  The consolidation will begin early in 2016 and should be complete by the end of that year.  In the third quarter of 2015, the Company recorded total pre-tax restructuring-related charges of $12

 

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million related to these plant closures, consisting of a $10 million charge for impaired assets and $2 million of employee severance-related costs.  Additional restructuring costs, although not expected to be significant, could be incurred in the future as part of the plant shutdowns.

 

Also, in the third quarter of 2015, the Company recorded a pre-tax restructuring charge of $2 million for estimated employee severance-related costs associated with the Port Colborne plant sale.

 

In the first quarter of 2015, the Company recorded a pre-tax restructuring charge of $10 million for employee severance-related costs associated with the Penford acquisition.

 

A summary of the Company’s restructuring reserve at September 30, 2015 is as follows (in millions):

 

Restructuring charge for employee severance costs-Penford acquisition		$	10
—Brazil plant shut-downs		2
—Port Colborne plant sale		2
Sub-total		$	14
Payments made to terminated employees		(2		)
Balance in restructuring reserve at September 30, 2015		$	12

 

The majority of the severance reserve is expected to be paid within the next twelve months.

 

6.                                      Segment Information

 

The Company is principally engaged in the production and sale of starches and sweeteners for a wide range of industries, and is managed geographically on a regional basis.  The Company’s operations are classified into four reportable business segments: North America, South America, Asia Pacific and Europe, Middle East and Africa (“EMEA”).  Its North America segment includes businesses in the United States, Canada and Mexico.  The Company’s South America segment includes businesses in Brazil, Colombia, Ecuador and the Southern Cone of South America, which includes Argentina, Chile, Peru and Uruguay.  Its Asia Pacific segment includes businesses in South Korea, Thailand, Malaysia, China, Japan, Indonesia, the Philippines, Singapore, India, Australia and New Zealand.  The Company’s EMEA segment includes businesses in the United Kingdom, Germany, South Africa, Pakistan and Kenya.

 

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		Three Months Ended September 30,						Nine Months Ended September 30,
(in millions)		2015			2014			2015			2014
Net Sales
North America		$	880.0		$	805.6		$	2,503.1		$	2,362.0
South America		256.4			307.6			764.5			906.2
Asia Pacific		174.4			205.8			553.1			594.3
EMEA		125.9			141.3			395.1			437.6
Total		$	1,436.7		$	1,460.3		$	4,215.8		$	4,300.1
Operating Income
North America		$	133.0		$	113.1		$	362.2		$	288.7
South America		28.4			27.4			73.0			73.8
Asia Pacific		27.6			27.0			81.3			80.1
EMEA		21.7			22.2			66.8			68.7
Corporate (a)		(18.3		)	(11.6		)	(54.4		)	(48.2		)
Sub-total		$	192.4		$	178.1		$	528.9		$	463.1
Impairment/restructuring charges		(13.8		)	—			(24.2		)	—
Acquisition/integration costs		(1.6		)	—			(9.3		)	—
Charge for fair value markup of acquired inventory		(2.0		)	—			(8.4		)	—
Total		$	175.0		$	178.1		$	487.0		$	463.1

 

(a)         Includes $4 million of expense relating to a tax indemnification agreement with offsetting income of $4 million recorded in the provision for income taxes for the three and nine months ended September 30, 2015.  For the three and nine months ended September 30, 2014, includes $7 million of income relating to this tax indemnification agreement with an offsetting expense of $7 million recorded in the provision for income taxes. See Note 14 for additional information.

 

(in millions)		At Sept. 30, 2015			At Dec. 31, 2014
Total Assets
North America		$	3,474		$	2,907
South America		740			923
Asia Pacific		719			711
EMEA		511			550
Total		$	5,444		$	5,091

 

7.                                      Financial Instruments, Derivatives and Hedging Activities

 

The Company is exposed to market risk stemming from changes in commodity prices (primarily corn and natural gas), foreign currency exchange rates and interest rates.  In the normal course of business, the Company actively manages its exposure to these market risks by entering into various hedging transactions, authorized under established policies that place clear controls on these activities.  These transactions utilize exchange-traded derivatives or over-the-counter derivatives with investment grade counterparties.  Derivative financial

 

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instruments currently used by the Company consist of commodity futures, options and swap contracts, foreign currency forward contracts and swaps, and interest rate swaps.

 

Commodity price hedging:  The Company’s principal use of derivative financial instruments is to manage commodity price risk in North America relating to anticipated purchases of corn and natural gas to be used in the manufacturing process, generally over the next twelve to twenty-four months.  To manage price risk related to corn purchases in North America, the Company uses corn futures and options contracts that trade on regulated commodity exchanges to lock-in its corn costs associated with firm-priced customer sales contracts.  The Company uses over-the-counter gas swaps to hedge a portion of its natural gas usage in North America.  These derivative financial instruments limit the impact that volatility resulting from fluctuations in market prices will have on corn and natural gas purchases and have been designated as cash-flow hedges.  Effective with the acquisition of Penford, the Company now produces and sells ethanol.  The Company now enters into swap contracts to hedge price risk associated with fluctuations in market prices of ethanol.  Unrealized gains and losses associated with marking the commodity hedging contracts to market (fair value) are recorded as a component of other comprehensive income (“OCI”) and included in the equity section of the Condensed Consolidated Balance Sheets as part of accumulated other comprehensive income/loss (“AOCI”).  These amounts are subsequently reclassified into earnings in the same line item affected by the hedged transaction and in the same period or periods during which the hedged transaction affects earnings, or in the month a hedge is determined to be ineffective.  The Company assesses the effectiveness of a commodity hedge contract based on changes in the contract’s fair value.  The changes in the market value of such contracts have historically been, and are expected to continue to be, highly effective at offsetting changes in the price of the hedged items.  The amounts representing the ineffectiveness of these cash-flow hedges are not significant.

 

At September 30, 2015, AOCI included $7 million of losses, net of tax of $3 million, pertaining to commodities-related derivative instruments designated as cash-flow hedges.  At December 31, 2014, AOCI included $13 million of losses, net of tax of $6 million, pertaining to commodities-related derivative instruments designated as cash-flow hedges.

 

Interest rate hedging:  Derivative financial instruments that have been used by the Company to manage its interest rate risk consist of Treasury Lock agreements (“T-Locks”) and interest rate swaps.  The Company did not have any T-locks outstanding at September 30, 2015 or December 31, 2014.  The Company has interest rate swap agreements that effectively convert the interest rates on its 3.2 percent $350 million senior notes due November 1, 2015, its 6.0 percent $200 million senior notes due April 15, 2017, its 1.8 percent $300 million senior notes due September 25, 2017 and on $200 million of its $400 million 4.625 percent senior notes due November 1, 2020, to variable rates.  These swap agreements call for the Company to receive interest at the fixed coupon rate of the respective notes and to pay interest at a variable rate based on the six-month US dollar LIBOR rate plus a spread.  The Company has designated these interest rate swap agreements as hedges of the changes in fair value of the underlying debt obligations attributable to changes in interest rates and accounts for them as fair-value hedges.  Changes in the fair value of interest rate swaps designated as hedging instruments that effectively offset the variability in the fair value of outstanding debt obligations are reported in earnings.  These amounts offset the gain or loss (that is, the change in fair value) of the hedged debt instrument that is attributable to changes in interest rates (that is, the hedged risk), which is also recognized in earnings.  The fair value of these interest rate swap agreements at September 30, 2015 and December 31, 2014 was $19 million and $13 million, respectively, and is reflected in the Condensed Consolidated Balance Sheets within other

 

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assets, with an offsetting amount recorded in long-term debt to adjust the carrying amount of the hedged debt obligations.

 

At September 30, 2015 and December 31, 2014, AOCI included $5 million of losses (net of income taxes of $3 million) and $7 million of losses (net of income taxes of $4 million), respectively, related to settled T-Locks.  These deferred losses are being amortized to financing costs over the terms of the senior notes with which they are associated.

 

Foreign currency hedging:  Due to the Company’s global operations, including operations in many emerging markets, it is exposed to fluctuations in foreign currency exchange rates.  As a result, the Company has exposure to translational foreign exchange risk when the results of its foreign operations are translated to US dollars and to transactional foreign exchange risk when transactions not denominated in the functional currency of an operating unit are revalued.  The Company primarily uses derivative financial instruments such as foreign currency forward contracts, swaps and options to manage its transactional foreign exchange risk.  At September 30, 2015, the Company had foreign currency forward sales contracts with an aggregate notional amount of $390 million and foreign currency forward purchase contracts with an aggregate notional amount of $47 million that hedged transactional exposures.  At December 31, 2014, the Company had foreign currency forward sales contracts with an aggregate notional amount of $150 million and foreign currency forward purchase contracts with an aggregate notional amount of $70 million that hedged transactional exposures.  The fair value of these derivative instruments are assets of $5 million and $1 million at September 30, 2015 and December 31, 2014, respectively.

 

The Company also has foreign currency derivative instruments that hedge certain foreign currency transactional exposures and are designated as cash-flow hedges. The amount included in AOCI relating to these hedges at both September 30, 2015 and December 31, 2014 was not significant.

 

The fair value and balance sheet location of the Company’s derivative instruments, accounted for as cash-flow hedges and presented gross in the Condensed Consolidated Balance Sheets, are reflected below:

 

		Fair Value of Derivative Instruments
Derivatives designated as				Fair Value								Fair Value
cash-flow hedging instruments: (in millions)		Balance Sheet Location		At Sept. 30, 2015			At December 31, 2014			Balance Sheet Location		At Sept. 30, 2015			At December 31, 2014
Commodity and foreign currency contracts		Accounts receivable-net		$	8		$	15		Accounts payable and accrued liabilities		$	11		$	18
Commodity and foreign currency contracts		Other assets		7			1			Non-current liabilities		3			6
Total				$	15		$	16				$	14		$	24

 

At September 30, 2015, the Company had outstanding futures and option contracts that hedged the forecasted purchase of approximately 77 million bushels of corn.  The Company also had outstanding swap and option contracts that hedged the forecasted purchase of

 

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approximately 19 million mmbtu’s of natural gas at September 30, 2015.  Additionally at September 30, 2015, the Company had outstanding ethanol swap contracts that hedged the forecasted sale of approximately 9 million gallons of ethanol.  The Company is unable to directly hedge price risk related to co-product sales; however, it occasionally enters into hedges of soybean oil (a competing product to corn oil) in order to mitigate the price risk of corn oil sales.  The Company did not have any soybean oil hedges at September 30, 2015.

 

Additional information relating to the Company’s derivative instruments is presented below (in millions, pre-tax):

 

		Amount of Gains (Losses) Recognized in OCI on Derivatives						Location of		Amount of Gains (Losses) Reclassified from AOCI into Income
Derivatives in Cash-Flow Hedging Relationships		Three Months Ended September 30, 2015			Three Months Ended September 30, 2014			Gains (Losses) Reclassified from AOCI into Income		Three Months Ended September 30, 2015			Three Months Ended September 30, 2014
Commodity and foreign currency contracts		$	(22	)	$	(71	)	Cost of sales		$	(9	)	$	(15	)
Interest rate contracts		—			—			Financing costs, net		(1		)	(1		)
Total		$	(22	)	$	(71	)			$	(10	)	$	(16	)

 

		Amount of Gains (Losses) Recognized in OCI on Derivatives						Location of		Amount of Gains (Losses) Reclassified from AOCI into Income
Derivatives in Cash-Flow Hedging Relationships		Nine Months Ended September 30, 2015			Nine Months Ended September 30, 2014			Gains (Losses) Reclassified from AOCI into Income		Nine Months Ended September 30, 2015			Nine Months Ended September 30, 2014
Commodity and foreign currency contracts		$	(26	)	$	(68	)	Cost of sales		$	(31	)	$	(33	)
Interest rate contracts		—			—			Financing costs, net		(2		)	(2		)
Total		$	(26	)	$	(68	)			$	(33	)	$	(35	)

 

At September 30, 2015, AOCI included $8 million of losses (net of income taxes of $3 million) on commodities-related derivative instruments designated as cash-flow hedges that are expected to be reclassified into earnings during the next twelve months.  The Company expects the losses to be offset by changes in the underlying commodities costs.  The Company also has $2 million of losses on settled T-Locks (net of income taxes of $1 million) recorded in AOCI at September 30, 2015, which are expected to be reclassified into earnings during the next twelve months.  Additionally, at September 30, 2015, AOCI included an insignificant amount of losses related to foreign currency hedges that are expected to be reclassified into earnings during the next twelve months.

 

Presented below are the fair values of the Company’s financial instruments and derivatives for the periods presented:

 

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		At September 30, 2015												At December 31, 2014
(in millions)		Total			Level 1			Level 2			Level 3			Total			Level 1			Level 2			Level 3
Available for sale securities		$	6		$	6		$	—		$	—		$	5		$	5		$	—		$	—
Derivative assets		39			7			32			—			29			12			17			—
Derivative liabilities		14			3			11			—			23			6			17			—
Long-term debt		2,356			—			2,356			—			1,939			—			1,939			—

 

Level 1 inputs consist of quoted prices (unadjusted) in active markets for identical assets or liabilities.  Level 2 inputs are inputs other than quoted prices included within Level 1 that are observable for the asset or liability, either directly or indirectly, for substantially the full term of the financial instrument.  Level 2 inputs are based on quoted prices for similar assets or liabilities in active markets, quoted prices for identical or similar assets or liabilities in markets that are not active, or inputs other than quoted prices that are observable for the asset or liability or can be derived principally from or corroborated by observable market data.  Level 3 inputs are unobservable inputs for the asset or liability.  Unobservable inputs shall be used to measure fair value to the extent that observable inputs are not available, thereby allowing for situations in which there is little, if any, market activity for the asset or liability at the measurement date.

 

The carrying values of cash equivalents, short-term investments, accounts receivable, accounts payable and short-term borrowings approximate fair values.  Commodity futures, options and swap contracts are recognized at fair value.  Foreign currency forward contracts, swaps and options are also recognized at fair value.  The fair value of the Company’s long-term debt is estimated based on quotations of major securities dealers who are market makers in the securities.  At September 30, 2015, the carrying value and fair value of the Company’s long-term debt were $2.24 billion and $2.36 billion, respectively.

 

8.                                      Share-Based Compensation

 

Stock Options:

 

Under the Company’s stock incentive plan, stock options are granted at exercise prices that equal the market value of the underlying common stock on the date of grant.  The options have a 10-year term and are exercisable upon vesting, which occurs over a three-year period at the anniversary dates of the date of grant.  Compensation expense is recognized on a straight-line basis for all awards.

 

The Company granted non-qualified options to purchase 336 thousand shares and 715 thousand shares of the Company’s common stock during the nine months ended September 30, 2015 and 2014, respectively.  The fair value of each option grant was estimated using the Black-Scholes option-pricing model with the following assumptions:

 

		For the Nine Months Ended September 30,
		2015		2014
Expected life (in years)		5.5		5.5
Risk-free interest rate		1.36	%	1.63	%
Expected volatility		25.19	%	30.28	%
Expected dividend yield		2.04	%	2.82	%

 

The expected life of options represents the weighted-average period of time that options granted are expected to be outstanding giving consideration to vesting schedules and the Company’s historical exercise patterns.  The risk-free interest rate is based on the US Treasury yield curve in effect at the grant date for the period corresponding to the expected life of the

 

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