9—FAIR VALUE MEASUREMENTS AND DERIVATIVE INSTRUMENTS

Fair Value Measurements

Presented below are the fair values of the Company’s derivatives as of May 31, 2014 and August 31, 2013:

 

(In thousands)
As of May 31, 2014		Level 1				Level 2				Level 3				Total
Current assets (Other):
Commodity derivatives		$	(2,899	)		$	—			$	—			$	(2,899	)
(In thousands)
As of August 31, 2013		Level 1				Level 2				Level 3				Total
Current assets (Other):
Commodity derivatives		$	512			$	—			$	—			$	512

 

The following table reconciles the gross fair value of assets and liabilities subject to offsetting arrangements to the net amounts recorded in the Condensed Consolidated Balance Sheets as Other current assets.

 

(In thousands)		Gross Amounts of Recognized Assets				Gross Liabilities Offset in the Balance Sheets				Net Amount of Assets (Liabilities)				Cash Collateral on Deposit with Counterparty				Net Fair Value as Recorded in Balance Sheets
As of May 31, 2014
Commodity derivatives		$	303			$	(3,202	)		$	(2,899	)		$	5,343			$	2,444
As of August 31, 2013
Commodity derivatives		$	997			$	(485	)		$	512			$	1,700			$	2,212

The three levels of inputs that may be used to measure fair value are:

 

•

Level 1 inputs are quoted prices (unadjusted) in active markets for identical assets or liabilities that the entity has the ability to access at the measurement date.

 

•

Level 2 inputs are other than quoted prices included within Level 1 that are observable for assets and liabilities such as (1) quoted prices for similar assets or liabilities in active markets, (2) quoted prices for identical or similar assets or liabilities in markets that are not active, or (3) inputs that are derived principally or corroborated by observable market data by correlation or other means.

 

•

Level 3 inputs are unobservable inputs to the valuation methodology for the assets or liabilities.

Other Financial Instruments

The carrying value of cash and cash equivalents, receivables and payables approximated fair value because of their short maturities. The Company’s bank debt reprices with changes in market interest rates and, accordingly, the carrying amount of such debt approximated fair value.

Commodity Contracts

For derivative instruments designated as fair value hedges, the gain or loss on the derivative instruments, as well as the offsetting gain or loss on the hedged firm commitments and/or inventory, are recognized in current earnings as a component of Cost of sales. For derivative instruments designated as cash flow hedges, the effective portion of the gain or loss on the derivative instruments is reported as a component of Other comprehensive income (loss), net of applicable income taxes, and recognized in earnings when the hedged exposure affects earnings. The Company recognizes the gain or loss on the derivative instrument as a component of Cost of sales in the period during which the finished goods produced from the hedged item are sold. If it is determined that the derivative instruments used are no longer effective at offsetting changes in the price of the hedged item, then the changes in fair value would be recognized in current earnings as a component of cost of sales.

To reduce the price volatility of corn used in fulfilling some of its starch sales contracts, Penford uses readily marketable exchange-traded futures, as well as forward cash corn purchases. Penford also uses exchange-traded futures to hedge corn inventories, firm commitments to purchase corn and forecasted purchases of corn. The exchange-traded futures are not purchased or sold for trading or speculative purposes and are designated as hedges.

Selling prices for ethanol fluctuate based on the availability and price of manufacturing inputs and the status of various government regulations and tax incentives. To reduce the risk of the price variability of ethanol, Penford enters into exchange-traded futures contracts to hedge exposure to ethanol price fluctuations. In the first quarter of fiscal 2014, the Company discontinued hedge accounting for certain ethanol futures contracts as they were not effective at offsetting changes in the selling prices of ethanol. The changes in the fair value of these futures contracts were recorded directly to Cost of sales. In the second quarter of fiscal 2014, the Company identified and entered into different exchange-traded ethanol swap contracts, which were designated as cash flow hedges.

Prices for natural gas fluctuate due to anticipated changes in supply and demand and movement of prices of related or alternative fuels. To reduce the price risk caused by market fluctuations, Penford may use exchange-traded futures contracts to hedge exposure to natural gas price fluctuations. These futures contracts do not qualify for hedge accounting and the changes in fair value were recognized in current earnings as a component of Cost of sales.

 

Hedged transactions are generally expected to occur within 12 months of the time the hedge is established. The deferred loss, net of tax, recorded in Accumulated other comprehensive loss at May 31, 2014 that is expected to be reclassified into income within 12 months is $0.9 million.

As of May 31, 2014, the Company had the following outstanding futures contracts:

 

Corn futures		4,775,000   Bushels
Ethanol futures		14,700,000 Gallons
Natural gas futures		40,000 mmbtu (millions of British thermal units)

The following tables provide information about the fair values of the Company’s derivatives, by contract type, as of May 31, 2014 and August 31, 2013:

 

		Assets												Liabilities
(In thousands)						Fair Value												Fair Value
		Balance Sheet Location				May 31, 2014				Aug 31, 2013				Balance Sheet Location				May 31, 2014				Aug 31, 2013
Derivatives designated as hedging instruments:
Cash flow hedges:
Corn futures			Other current assets			$	—			$	—				Other current assets			$	788			$	485
Ethanol futures			Other current assets				—				997				Other current assets				2,414				—
Fair value hedges:
Corn futures			Other current assets				300				—				Other current assets				—				—
Derivatives not designated as hedging instruments:
Natural gas futures			Other current assets				3				—				Other current assets				—				—
						$	303			$	997							$	3,202			$	485

 

The following tables provide information about the effect of derivative instruments on the financial performance of the Company for the three- and nine-month periods ended May 31, 2014 and 2013:

 

(In thousands)		Amount of Gain (Loss) Recognized in OCI								Amount of Gain (Loss) Reclassified from AOCI into Income								Amount of Gain (Loss) Recognized in Income
		3 Months Ended May 31,								3 Months Ended May 31,								3 Months Ended May 31,
		2014				2013				2014				2013				2014				2013
Derivatives designated as hedging instruments:
Cash flow hedges:
Corn futures (1)		$	760			$	530			$	1,744			$	596			$	(198	)		$	(474	)
Ethanol futures (1)			(4,128	)			(557	)			(5,760	)			(355	)			(260	)			—
		$	(3,368	)		$	(27	)		$	(4,016	)		$	241			$	(458	)		$	(474	)
Fair value hedges:
Corn futures (1) (2)																		$	(21	)		$	143
Derivatives not designated as hedging instruments:
Natural gas futures (1)																		$	(854	)		$	294
Natural gas options (1)																			—				(20	)
Soybean meal futures (1)																			5				—
																		$	(849	)		$	274

 

(1)	Gains and losses reported in Cost of sales

(2)	Hedged items are firm commitments and inventory

 

(In thousands)		Amount of Gain (Loss) Recognized in OCI								Amount of Gain (Loss) Reclassified from AOCI into Income								Amount of Gain (Loss) Recognized in Income
		9 Months Ended May 31,								9 Months Ended May 31,								9 Months Ended May 31,
		2014				2013				2014				2013				2014				2013
Derivatives designated as hedging instruments:
Cash flow hedges:
Corn futures (1)		$	81			$	(43	)		$	(2,116	)		$	4,087			$	(1,595	)		$	(589	)
Ethanol futures (1)			(9,688	)			429				(7,368	)			(71	)			(331	)			(11	)
		$	(9,607	)		$	386			$	(9,484	)		$	4,016			$	(1,926	)		$	(600	)
Fair value hedges:
Corn futures (1) (2)																		$	75			$	127
Derivatives not designated as hedging instruments:
Natural gas futures (1)																		$	(634	)		$	(16	)
Natural gas options (1)																			—				(20	)
Soybean meal futures (1)																			11
Ethanol futures (1)																			64				—
																		$	(559	)		$	(36	)

 

(1)	Gains and losses reported in Cost of sales

(2)	Hedged items are firm commitments and inventory