10-K 1 cenex025288_10k.txt CENEX HARVEST STATES COOPERATIVES FORM 10-K -------------------------------------------------------------------------------- SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 ----------------- FORM 10-K ----------------- [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE FISCAL YEAR ENDED AUGUST 31, 2002 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: 333-17865 ----------------- CENEX HARVEST STATES COOPERATIVES (Exact name of registrant as specified in its charter) MINNESOTA 41-0251095 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification Number) 5500 CENEX DRIVE (651) 451-5151 INVER GROVE HEIGHTS, MINNESOTA 55077 (Registrant's Telephone number, (Address of principal executive office) including area code) ----------------- SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT: NONE SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT: NONE ----------------- 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 _____ Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K: Not applicable State the aggregate market value of the voting stock held by non-affiliates of the registrant: The registrant has no voting stock outstanding. Indicate the number of shares outstanding of each of the registrant's classes of common stock, as of the latest practicable date: The registrant has no common stock outstanding. DOCUMENTS INCORPORATED BY REFERENCE None. -------------------------------------------------------------------------------- INDEX
PART I. PAGE NO. -------- Item 1. Business Cautionary Statement ................................................................... 1 The Company ............................................................................ 1 Agronomy ............................................................................... 2 Energy ................................................................................. 4 Country Operations ..................................................................... 6 Grain Marketing ........................................................................ 7 Processed Grains and Foods ............................................................. 9 Price Risk and Hedging ................................................................. 12 Employees .............................................................................. 13 Membership in the Company and Authorized Capital ....................................... 13 Item 2. Properties ............................................................................. 16 Item 3. Legal Proceedings ...................................................................... 17 Item 4. Submission of Matters to a Vote of Security Holders .................................... 17 PART II. Item 5. Market for Registrant's Common Equity and Related Stockholder Matters .................. 18 Item 6. Selected Financial Data ................................................................ 18 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations ................................................................ 20 Item 7(a). Quantitative and Qualitative Disclosures about Market Risk ............................. 30 Item 8. Financial Statements and Supplementary Data ............................................ 31 Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure ... 31 PART III. Item 10. Directors and Executive Officers of the Registrant Board of Directors ..................................................................... 32 Executive Officers ..................................................................... 36 Item 11. Executive Compensation ................................................................. 38 Item 12. Security Ownership of Certain Beneficial Owners and Management ......................... 44 Item 13. Certain Relationships and Related Transactions ......................................... 44 PART IV. Item 14. Controls and Procedures ................................................................ 45 Item 15. Exhibits, Financial Statements and Reports Filed on Form 8-K ........................... 45 SUPPLEMENTAL INFORMATION .......................................................................... 48 SIGNATURES ........................................................................................ 49 SECTION 302 CERTIFICATIONS ........................................................................ 50
PART I. ITEM 1. BUSINESS CAUTIONARY STATEMENT FOR PURPOSES OF THE SAFE HARBOR PROVISIONS OF THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995 THE INFORMATION IN THIS ANNUAL REPORT ON FORM 10-K FOR THE YEAR ENDED AUGUST 31, 2002, INCLUDES "FORWARD-LOOKING STATEMENTS" WITHIN THE MEANING OF THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995 WITH RESPECT TO THE COMPANY. IN ADDITION, THE COMPANY AND ITS REPRESENTATIVES AND AGENTS MAY FROM TIME TO TIME MAKE OTHER WRITTEN OR ORAL FORWARD-LOOKING STATEMENTS, INCLUDING STATEMENTS CONTAINED IN THE COMPANY'S FILINGS WITH THE SECURITIES AND EXCHANGE COMMISSION AND ITS REPORTS TO ITS MEMBERS AND SECURITYHOLDERS. WORDS AND PHRASES SUCH AS "WILL LIKELY RESULT," "ARE EXPECTED TO," "WILL CONTINUE," "IS ANTICIPATED," "ESTIMATE," "PROJECT" AND SIMILAR EXPRESSIONS IDENTIFY FORWARD-LOOKING STATEMENTS. THE COMPANY WISHES TO CAUTION READERS NOT TO PLACE UNDUE RELIANCE ON ANY FORWARD-LOOKING STATEMENTS, WHICH SPEAK ONLY AS OF THE DATE MADE. THE COMPANY'S FORWARD-LOOKING STATEMENTS ARE SUBJECT TO RISKS AND UNCERTAINTIES THAT COULD CAUSE ACTUAL RESULTS TO DIFFER MATERIALLY FROM THOSE DISCUSSED IN THE FORWARD-LOOKING STATEMENTS. THESE RISKS AND UNCERTAINTIES INCLUDE, BUT ARE NOT LIMITED TO, RISKS RELATED TO THE LEVEL OF COMMODITY PRICES, LOSS OF MEMBER BUSINESS, COMPETITION, CHANGES IN THE TAXATION OF COOPERATIVES, COMPLIANCE WITH LAWS AND REGULATIONS, PERCEPTIONS OF FOOD QUALITY AND SAFETY, BUSINESS INTERRUPTIONS AND CASUALTY LOSSES, ACCESS TO EQUITY CAPITAL, CONSOLIDATION OF PRODUCERS AND CUSTOMERS, FLUCTUATIONS IN PRICES FOR CRUDE OIL AND REFINED PETROLEUM PRODUCTS, ALTERNATIVE ENERGY SOURCES, THE PERFORMANCE OF OUR AGRONOMY BUSINESS AND JOINT VENTURES. THESE RISKS AND UNCERTAINTIES ARE FURTHER DESCRIBED IN EXHIBIT 99.1 TO THIS ANNUAL REPORT ON FORM 10-K, AND OTHER RISKS OR UNCERTAINTIES MAY BE DESCRIBED FROM TIME TO TIME IN THE COMPANY'S FUTURE FILINGS WITH THE SECURITIES AND EXCHANGE COMMISSION. THE COMPANY UNDERTAKES NO OBLIGATION TO REVISE ANY FORWARD-LOOKING STATEMENTS TO REFLECT FUTURE EVENTS OR CIRCUMSTANCES. THE COMPANY Cenex Harvest States Cooperatives (CHS Cooperatives, CHS or the Company) is one of the nation's leading integrated agricultural companies. As a cooperative, the Company is owned by farmers and ranchers and their local cooperatives from the Great Lakes to the Pacific Northwest and from the Canadian border to Texas. CHS Cooperatives buys commodities from and provides products and services to its members and other customers. The Company provides a wide variety of products and services, from initial agricultural inputs such as fuels, farm supplies and crop nutrients, to agricultural outputs that include grains and oilseeds, grain and oilseed processing and food products. A portion of the Company's operations are conducted through equity investments and joint ventures whose operating results are not consolidated with the Company's results; rather, a proportionate share of the income from those entities is included as a component in the Company's net income under the equity method of accounting. For the fiscal year ended August 31, 2002, the Company's total revenues were $7.8 billion. The Company's operations are organized into five business segments: Agronomy, Energy, Country Operations, Grain Marketing and Processed Grains and Foods. Together these business segments create vertical integration to link producers with consumers. The first two segments, Agronomy and Energy, produce and provide for the wholesale distribution of inputs that are essential for crop production. The third segment, Country Operations, serves as the Company-owned retailer of a portion of these crop inputs and also serves as the first handler of a significant portion of the crops marketed and processed by the Company. The fourth segment, Grain Marketing, purchases and resells grains and oilseeds originated by the Country Operations segment, by member cooperatives and by third parties. The fifth business segment, Processed Grains and Foods, converts grains and oilseeds into value-added products. Only producers of agricultural products and associations of producers of agricultural products may be members of CHS Cooperatives. The Company's earnings are allocated to members based on the 1 volume of business they do with the Company. Members receive earnings in the form of patronage refunds in cash and patron's equities, which may be redeemed over time. The origins of CHS Cooperatives date back to the early 1930s with the founding of the predecessor companies of Cenex, Inc. and Harvest States Cooperatives. Cenex Harvest States Cooperatives, now headquartered in Inver Grove Heights, Minnesota, emerged as the result of the merger of the two entities in 1998. The international sales information and segment information in Notes 2 and 11 to the financial statements are incorporated by reference into the following business segment descriptions. The business segment financial information presented below does not represent the results that would have been obtained had the relevant business segment been operated as an independent business. AGRONOMY OVERVIEW Through the Agronomy business segment, the Company is engaged in the manufacture of crop nutrients and the wholesale distribution of crop nutrients and crop protection products. The Company conducts its agronomy operations primarily through two investments -- a 20% cooperative ownership interest in CF Industries, Inc. (CF Industries) and, effective January 2000, a 25% ownership interest in Agriliance, LLC (Agriliance). CF Industries manufactures crop nutrient products, particularly nitrogen and phosphate fertilizers, and is one of the largest suppliers to Agriliance. Agriliance is one of North America's largest wholesale distributors of crop nutrients, crop protection products and other agronomy products. There is significant seasonality in the sale of crop nutrients and crop protection products and services, with peak activity coinciding with the planting and input seasons. The Company's minority ownership interests in CF Industries and Agriliance are treated as investments, and therefore, those entities' revenues and expenses are not reflected in the Company's operating results. Each of CF Industries and Agriliance has its own line of financing, without recourse to the Company. OPERATIONS CF INDUSTRIES. CF Industries is an interregional agricultural cooperative involved in the manufacturing of crop nutrient products. It is one of North America's largest producers of nitrogen and phosphate fertilizers. Through its members, CF Industries' nitrogen and phosphate fertilizer products reach farmers and ranchers in 48 states and two Canadian provinces. CF Industries conducts its operations primarily from the following facilities: o a nitrogen manufacturing and processing facility at Donaldsonville, Louisiana; o a phosphate mine and phosphate fertilizer plant in central Florida; and o a 66% ownership interest in a nitrogen fertilizer manufacturing and processing facility in Alberta, Canada. AGRILIANCE. Agriliance is the one of the nation's largest wholesale distributors of crop nutrients (fertilizers) and crop protection products (insecticides, fungicides and pesticides), accounting for an estimated 30% of the U.S. market for crop nutrients and approximately 25% of the U.S. market for crop protection products. As a wholesale distributor, Agriliance has warehouse, distribution and service facilities located throughout the country. Agriliance also owns and operates retail agricultural units in the southeastern United States. Agriliance purchases most of its fertilizer from CF Industries and Farmland Industries, Inc. (Farmland) and its crop protection products from Monsanto and Sygenta. Agriliance was formed in 2000 when CHS Cooperatives, Farmland and Land O'Lakes, Inc. (Land O'Lakes) contributed their respective agronomy businesses to the new company in consideration for ownership interests (25% each for CHS and Farmland and 50% for Land O'Lakes) in the venture. CHS Cooperatives and Farmland hold their interests in Agriliance through United Country Brands, LLC, a jointly-owned holding company. 2 PRODUCTS AND SERVICES CF Industries manufactures crop nutrient products, primarily nitrogen and phosphate fertilizers and potash. Agriliance wholesales crop nutrient products and crop protection products that include insecticides, fungicides, and pesticides. Agriliance also provides field and technical services, including soil testing, adjuvant and herbicide formulation, application and related services. SALES AND MARKETING; CUSTOMERS CF Industries sells its crop nutrient products to large agricultural cooperatives and distributors. Its largest customers are Land O'Lakes, CHS and seven other regional cooperatives that wholesale the products to their members. Agriliance distributes agronomy products through approximately 1,000 local cooperatives from Ohio to the West Coast and from the Canadian border south to Kansas. Agriliance also provides sales and services through 48 Agriliance Service Centers and other retail outlets. Agriliance's largest customer is the Company's Country Operations business segment. In 2002, Agriliance sold approximately $1.4 billion of crop nutrient products and approximately $2.2 billion of crop protection and other products. INDUSTRY; COMPETITION CF INDUSTRIES. North American fertilizer producers operate in a highly competitive, global industry. Commercial fertilizers are world-traded commodities and producers compete principally on the basis of price and service. Many of the raw materials that are used in fertilizer production, such as natural gas, are often more expensive in the U.S. than other parts of the world. Crop nutrient margins have historically been cyclical; large profits generated throughout the mid-1990's attracted additional capital and expansion and the industry now suffers from excess capacity. These factors have produced depressed margins for North American fertilizer manufacturers over the past several years, although recently fertilizer margins have stabilized as natural gas prices have declined. CF Industries competes with numerous domestic and international crop nutrient manufacturers, including Farmland. AGRILIANCE. The wholesale distribution of agronomy products is highly competitive and dependent upon relationships with agricultural producers and local cooperatives, proximity to producers and local cooperatives and competitive pricing. Moreover, the crop protection products industry is mature with slow growth predicted for the future, which has led distributors and suppliers to turn to consolidation and strategic partnerships to benefit from economies of scale and increased market share. Agriliance competes with other large agronomy distributors, as well as other regional or local distributors and retailers. Agriliance competes on the strength of its relationships with the members of the Company, Farmland and Land O'Lakes, its purchasing power and competitive pricing, and its attention to service in the field. Major competitors of Agriliance in crop nutrient distribution include Agrium, Growmark, United Suppliers and West Central. Major competitors of Agriliance in crop protection products distribution include Helena, ConAgra (UAP), Tenkoz and numerous smaller distribution companies. SUMMARY OPERATING RESULTS The Company accounts for its Agronomy business segment as follows: CF INDUSTRIES. The Company's investment in CF Industries of $153 million on August 31, 2002, is carried on the balance sheet at cost, including allocated patronage. Since CF Industries is a cooperative, the Company recognizes income from the investment only if it receives patronage refunds. In recent years, CF Industries has realized operating losses and as such, it has not issued any patronage refunds to its members. Historically, crop nutrients manufacturing earnings have been cyclical in nature. AGRILIANCE. At August 31, 2002 the Company's equity investment in Agriliance was $86 million. The Company recognizes earnings from Agriliance using the equity method of accounting, which results in the Company including its ownership percentage of Agriliance's net earnings as equity income from investments. The Company applies related internal expenses against those earnings. 3 Summary operating results for the Agronomy business segment for the fiscal years ended August 31, 2002, 2001 and 2000 are shown below:
2002 2001 2000 ----------- ----------- ----------- (DOLLARS IN THOUSANDS) Revenues: Net sales* .................................... $808,659 Patronage dividends ........................... $ (89) $ 196 224 Other revenues ................................ 5,817 --------- -------- -------- (89) 196 814,700 Cost of goods sold ............................. 764,744 Marketing, general and administrative .......... 8,957 8,503 20,832 --------- -------- -------- Operating (losses) earnings .................... (9,046) (8,307) 29,124 Interest ....................................... (1,403) (4,529) (3,512) Equity (income) loss from investments .......... (13,425) (7,360) 4,336 --------- -------- -------- Income before income taxes ..................... $ 5,782 $ 3,582 $ 28,300 ========= ======== ======== Total identifiable assets -- August 31 ......... $ 242,015 $230,051 $228,277 ========= ======== ========
------------------ * Net sales in 2000 reflect sales from the Company's agronomy business prior to the time it was contributed to Agriliance. Earnings from the Company's interest in Agriliance are shown as equity (income) loss from investments. ENERGY OVERVIEW CHS Cooperatives is the nation's largest cooperative energy company, with operations that include petroleum refining and pipelines; the supply, marketing and distribution of refined fuels (gasoline, diesel, and other energy products); the blending, sale and distribution of lubricants; and the wholesale and retail supply of propane. The Energy business segment processes crude oil into refined petroleum products at refineries in Laurel, Montana (wholly-owned) and McPherson, Kansas (owned by an entity in which CHS has an approximate 74.5% ownership interest) and sells those products under the Cenex brand to CHS's member cooperatives and others through a network of approximately 1,400 independent retailers, including approximately 800 that operate Cenex/Ampride convenience stores. OPERATIONS LAUREL REFINERY. The Company's Laurel, Montana refinery processes medium and high sulfur crude oil into refined petroleum products that primarily include gasoline, diesel, and asphalt. The Laurel refinery sources approximately 90% of its crude oil supply from Canada, with the balance obtained from domestic sources. Laurel has access to Canadian and northwest Montana crude through the Company's wholly-owned Front Range Pipeline and other common carrier pipelines. The Laurel refinery also has access to Wyoming crude via common carrier pipelines from the south. The Laurel facility processes approximately 55,000 barrels of crude oil per day to produce refined products that consist of approximately 42% gasoline, 30% diesel and 28% asphalt and other residual products. Refined fuels produced at Laurel, Montana are available via the Yellowstone Pipeline to western Montana terminals and to Spokane and Moses Lake, Washington, south via common carrier pipelines to Wyoming terminals and Denver, Colorado, and east via the Company's wholly-owned Cenex Pipeline to Glendive, Montana, and Minot and Fargo, North Dakota. MCPHERSON REFINERY. The McPherson, Kansas refinery is owned and operated by the National Cooperative Refinery Association (NCRA), of which the Company owns approximately 74.5%. The McPherson refinery processes low and medium sulfur crude oil into gasoline, diesel and other distillates, propane, and other products. McPherson sources approximately 95% of its crude oil from Kansas, Oklahoma, and Texas through NCRA-owned and common carrier pipelines. The McPherson refinery processes approximately 80,000 barrels of crude oil per day to produce refined products that consist of approximately 57% gasoline, 34% diesel and other distillates, and 9% propane and other products. Approximately 90% of the refined fuels are shipped via NCRA's 4 proprietary products pipeline to its terminal in Council Bluffs, Iowa and to other markets via common carrier pipelines. The balance of the fuels are loaded into trucks at the refinery. OTHER ENERGY OPERATIONS. The Company owns and operates ten propane plants and three propane terminals, four asphalt terminals, three lubricants blending and packaging facilities, and 36 convenience stores. The Company also owns and leases a fleet of liquid and pressure trailers and tractors which are used to transport refined fuels, propane and anhydrous ammonia. PRODUCTS AND SERVICES The Energy business segment produces and sells (primarily wholesale) gasoline, diesel, propane, asphalt, and lubricants. It obtains the petroleum products that it sells both from the Laurel and McPherson refineries and from third parties. SALES AND MARKETING; CUSTOMERS The Company makes approximately 85% of its refined fuel sales to members, with the balance sold to non-members. Sales are made wholesale to member cooperatives and through a network of independent retailers that operate convenience stores under the Cenex/Ampride tradename. The Company sold approximately 1.3 billion gallons of gasoline and approximately 1.2 billion gallons of diesel fuel in fiscal year 2002. The Company also wholesales auto and farm machinery lubricants to both members and non-members. In fiscal year 2002, energy operations sold approximately 26.4 million gallons of lubricants. The Company is one of the nation's largest propane wholesalers. In fiscal year 2002, energy operations sold approximately 0.7 billion gallons of propane. Most of the propane sold in rural areas is for heating and agricultural consumption. Annual sales volumes of propane vary greatly depending on weather patterns and crop conditions. INDUSTRY; COMPETITION Governmental regulations and policies, particularly in the areas of taxation, energy and the environment, have a significant impact on the Company's energy operations segment. Like many other refineries, the Energy business segment's refineries are currently focusing their capital spending on reducing pollution. In particular, these refineries are currently working to comply with the federal government's initiatives to lower the sulfur content of gasoline and diesel. The Company currently expects that the cost of compliance, which will be spread out over the next four years, will be approximately $340 million in total for the McPherson and Laurel refineries. It is expected that over 80% of the costs will be incurred at the McPherson refinery. The energy business is highly cyclical. Demand for crude oil and its products are driven by the condition of local and worldwide economies, local and regional weather patterns and taxation relative to other energy sources. Most of the Company's energy product market is located in rural areas, so sales activity tends to follow the planting and harvesting cycles. More fuel efficient equipment, reduced crop tillage, depressed prices for crops, warm winter weather, and government programs which encourage idle acres may all reduce demand for the Company's energy products. The refining and wholesale fuels business is very competitive. Among the Company's competitors are some of the world's largest integrated petroleum companies, which have their own crude oil supplies, distribution and marketing systems. The Company also competes with smaller domestic refiners and marketers in the midwestern and northwestern United States, with foreign refiners who import products into the United States and with producers and marketers in other industries supplying other forms of energy and fuels to consumers. Given the commodity nature of the end products, profitability in the refining and marketing industry depends largely on margins, as well as operating efficiency, product mix, and costs of product distribution and transportation. The retail gasoline market is highly competitive, with much larger competitors that have greater brand recognition and distribution outlets throughout the country and the world. CHS Cooperatives owned and non-owned retail outlets are located primarily in the southern, midwestern and northwestern United States. 5 SUMMARY OPERATING RESULTS Summary operating results for the Energy business segment for the fiscal years ended August 31, 2002, 2001 and 2000 are shown below:
2002 2001 2000 ------------- ------------- ------------- (DOLLARS IN THOUSANDS) Revenues: Net sales ..................................... $2,657,689 $2,781,243 $2,959,622 Patronage dividends ........................... 458 712 311 Other revenues ................................ 6,392 4,036 2,792 ---------- ---------- ---------- 2,664,539 2,785,991 2,962,725 Cost of goods sold ............................. 2,489,352 2,549,099 2,862,715 Marketing, general and administrative .......... 66,731 48,432 43,332 ---------- ---------- ---------- Operating earnings ............................. 108,456 188,460 56,678 Interest ....................................... 16,875 25,097 27,926 Equity loss (income) from investments .......... 1,166 4,081 (856) Minority interests ............................. 14,604 34,713 24,443 ---------- ---------- ---------- Income before income taxes ..................... $ 75,811 $ 124,569 $ 5,165 ========== ========== ========== Total identifiable assets -- August 31 ......... $1,305,828 $1,154,036 $1,379,019 ========== ========== ==========
COUNTRY OPERATIONS OVERVIEW The Country Operations business segment purchases wheat and other grains from the Company's producer members and provides cooperative members and producers with access to a full range of products and services including farm supplies, programs for crop and livestock production, hedging and insurance services, and agricultural operations financing. Country Operations operates at approximately 300 locations dispersed throughout Minnesota, North Dakota, South Dakota, Nebraska, Montana, Idaho, Washington and Oregon. Most of these locations purchase grain from farmers and sell agronomy products, energy products and feed to those same producers and others, although not all locations provide every product and service. PRODUCTS AND SERVICES GRAIN PURCHASING. The Company is one of the largest country elevator operators in North America. Through a majority of its elevator locations, the Country Operations business segment purchases grain from member and non-member producers and other elevators and grain dealers. Most of the grain purchased is either sold through the Company's Grain Marketing business segment or used for local feed and processing operations. In the year ended August 31, 2002, the Company purchased approximately 280 million bushels of grain, primarily wheat (131 million bushels), corn (77 million bushels) and soybeans (45 million bushels). Of these bushels, 255 million were purchased from members and 239 million were sold through the Grain Marketing business segment. FARM SUPPLIES. Country Operations manufactures and sells farm supplies, both directly and through ownership interests in other entities. These include seed; plant food; energy products; animal feed ingredients, supplements and products; animal health products; and crop protection products. The Company sells agronomy products at 160 locations, feed products at 135 locations and energy products at 94 locations. Farm supplies are purchased through cooperatives whenever possible. FINANCIAL SERVICES. The Company has provided open account financing to more than 150 CHS members that are cooperatives (Cooperative Association Members) in the past year. These arrangements involve the discretionary extension of credit in the form of term and seasonal loans and can also be used as a clearing account for settlement of grain purchases and as a cash management tool. A substantial part of the term and seasonal loans are sold to the National Bank for Cooperatives (CoBank), with CoBank purchasing up to 90% of any loan. The Company's borrowing arrangements with CoBank limit loan balances outstanding under this program to not more than $150.0 million at any one time. 6 Through its wholly-owned subsidiary Fin-Ag, Inc. the Company provides seasonal cattle feeding and swine financing loans, facility financing loans and crop production loans. It also provides consulting services to member cooperatives. Most loans are sold to CoBank under a separate program from that described above, under which the Company has guaranteed a portion of the loans. The Company's exposure at August 31, 2002 was approximately $40.8 million. Under the Company's borrowing arrangements, the maximum amount of the loans outstanding at any one time may not exceed $125.0 million and the Company's maximum guarantee exposure would be $48.5 million. The Company's wholly-owned subsidiary Country Hedging, Inc., which is a registered futures commission merchant and a clearing member of both the Minneapolis Grain Exchange and the Kansas City Board of Trade, is a full service commodity futures and options broker. Ag States Agency, LLC is an independent insurance agency in which the Company holds a majority ownership interest. It sells insurance, including group benefits, property and casualty, and bonding programs. Its more than 1,700 customers are primarily agricultural businesses, including local cooperatives and independent elevators, oil stations, agronomy and feed/seed plants, implement dealers, fruit and vegetable packers/warehouses, and food processors. INDUSTRY; COMPETITION Competitors for the purchase of grain include other elevators and large grain marketing companies. Competitors for farm supply include a variety of cooperatives, privately held and large national companies. The Company competes primarily on the basis of price, services and patronage. The financing operations are not significant, however, competitors for the Company's financing operations are primarily other financial institutions. The Company competes primarily on the basis of price, services and patronage. Country Hedging's competitors include international brokerage firms, national brokerage firms, regional brokerage firms (both cooperatives and non-cooperatives) as well as local introducing brokers, with competition driven both by price and level of service. Ag States competes with other insurance agencies, primarily on the basis of price and services. SUMMARY OPERATING RESULTS Summary operating results for the Country Operations business segment for the fiscal years ended August 31, 2002, 2001 and 2000 are shown below:
2002 2001 2000 ------------- ------------- ------------- (DOLLARS IN THOUSANDS) Revenues: Net sales ..................................... $1,474,553 $1,577,268 $1,409,892 Patronage dividends ........................... 2,572 3,683 3,830 Other revenues ................................ 80,789 80,479 68,436 ---------- ---------- ---------- 1,557,914 1,661,430 1,482,158 Cost of goods sold ............................. 1,471,422 1,569,884 1,404,120 Marketing, general and administrative .......... 47,995 53,417 44,136 ---------- ---------- ---------- Operating earnings ............................. 38,497 38,129 33,902 Interest ....................................... 13,851 15,695 12,782 Equity income from investments ................. (283) (246) (1,007) Minority interests ............................. 786 385 103 ---------- ---------- ---------- Income before income taxes ..................... $ 24,143 $ 22,295 $ 22,024 ========== ========== ========== Total identifiable assets -- August 31 ......... $ 799,711 $ 679,053 $ 660,358 ========== ========== ==========
GRAIN MARKETING OVERVIEW CHS Cooperatives is the nation's largest cooperative marketer of grain and oilseed, handling about 1.1 billion bushels annually. During fiscal year 2002, the Company purchased approximately 76% of total 7 grain volumes from individual and member cooperatives and the Country Operations business segment, with the balance purchased from third parties. CHS Cooperatives arranges for the transportation of the grains either directly to customers or to Company owned or leased grain terminals and elevators pending delivery to domestic and foreign purchasers. The Company primarily conducts its Grain Marketing operations directly, but does conduct some of its business through three 50% owned joint ventures. OPERATIONS The Grain Marketing segment purchases grain directly and indirectly from agricultural producers primarily in the Midwestern and Western United States. The purchased grain is typically sold for future delivery at a specified location, with the Company responsible for handling the grain and arranging for its transportation to that location. The Company's ability to arrange efficient transportation, including loading capabilities onto unit trains, ocean-going vessels, and barges, is a significant part of the service it offers to its customers. Rail, vessel, barge and truck transportation is carried out by third parties, often under long-term freight agreements with the Company. Grain intended for export is usually shipped by rail or barge to an export terminal, where it is loaded onto ocean-going vessels. Grain intended for domestic use is usually shipped by rail or truck to various locations throughout the country. CHS owns export terminals, river terminals, and elevators involved in the handling and transport of grain. River terminals at Kansas City, Missouri, St. Paul, Savage, and Winona, Minnesota, and Davenport, Iowa are used to load grains onto barges for shipment to both domestic and export customers via the Mississippi River System. The Company's export terminal at Superior, Wisconsin provides access to the Great Lakes and St. Lawrence Seaway, and an export terminal at Myrtle Grove, Louisiana serves the Gulf market. In the Pacific Northwest, the Company conducts its grain marketing operations through United Harvest, LLC (a 50% joint venture with United Grain Corporation) and TEMCO, LLC (a 50% joint venture with Cargill, Incorporated). United Harvest, LLC operates grain terminals in Vancouver and Kalama, Washington. TEMCO, LLC operates a large export terminal in Tacoma, Washington. These facilities serve the Pacific market, as well as domestic grain customers in the Western United States. Grain Supplier, LLC (a 50% joint venture with Commodity Specialists Company) will begin operating an elevator facility in Friona, Texas and one in Collins, Mississippi beginning in late fiscal year 2003 or early fiscal year 2004. Grain Marketing purchases most of its grain during the summer and fall harvest period. Because of the Company's geographic location and the fact that it is further from its export facilities, grain tends to be sold later than in other parts of the country. However, as many producers have significant on-farm storage capacity and in light of the Company's own storage capacity, the Grain Marketing business segment buys and ships grain throughout the year. Due to the amount of grain purchased and held in inventory, the Grain Marketing business segment has significant working capital needs at various times of the year. The amount of borrowings for this purpose, and the interest rate charged on those borrowings, directly affect the profitability of the Grain Marketing segment. PRODUCTS AND SERVICES The primary grains purchased by the Grain Marketing business segment for the year ended August 31, 2002 were wheat (362 million bushels), corn (393 million bushels) and soybeans (241 million bushels). Of the total grains purchased by the Grain Marketing segment during the year ended August 31, 2002, 571 million bushels were purchased from the Company's individual and cooperative association members, 239 million bushel were purchased from the Country Operations business segment and the remainder were purchased from third parties. SALES AND MARKETING; CUSTOMERS Purchasers include domestic and foreign millers, maltsters, feeders, crushers, and other processors. To a much lesser extent purchasers include intermediaries and distributors. Grain marketing operations are not dependent on any one customer. The Grain Marketing segment has supply relationships calling for delivery of grain at prevailing market prices. INDUSTRY; COMPETITION The Grain Marketing business segment competes for both the purchase and sale of grain. Competition is intense and margins are low. Some competitors are integrated food producers, which may also be customers. A few major competitors have substantially greater financial resources than the Company. 8 In the purchase of grain from producers, location of the delivery facility is a prime consideration, but producers are increasingly willing to truck grain longer distances for sale. Price is affected by the capabilities of the facility; for example, if it is cheaper to deliver to a customer by unit train than by truck, a facility with unit train capability provides a price advantage. The Company believes that its relationships with individual members serviced by local Country Operations locations and with cooperative members gives it a broad origination capability. The Grain Marketing business segment competes for grain sales based on price, services and ability to provide the desired quantity and quality of grains required. Location of facilities is a major factor in the ability to compete. Grain marketing operations compete with numerous grain merchandisers, including major grain merchandising companies such as Archer Daniels Midland (ADM), Cargill, Incorporated (Cargill), ConAgra, Bunge and Louis Dreyfus, each of which handle grain volumes of more than one billion bushels annually. The results of the grain marketing business may be adversely affected by relative levels of supply and demand, both domestic and international, commodity price levels (including grain prices reporting on national markets) and transportation costs and conditions. Supply is affected by weather conditions, disease, insect damage, acreage planted and government regulations and policies. Demand may be affected by foreign governments and their programs, relationships of foreign countries with the United States, the affluence of foreign countries, acts of war, currency exchange fluctuations and substitution of commodities. Demand may also be affected by changes in eating habits, by population growth, and by increased or decreased per capita consumption of some products. SUMMARY OPERATING RESULTS Summary operating results for the Grain Marketing business segment for the fiscal years ended August 31, 2002, 2001 and 2000 are shown below:
2002 2001 2000 ------------- ------------- ------------- (DOLLARS IN THOUSANDS) Revenues: Net sales ..................................... $3,787,322 $3,514,314 $3,453,807 Patronage dividends ........................... 497 840 861 Other revenues ................................ 21,902 22,964 15,440 ---------- ---------- ---------- 3,809,721 3,538,118 3,470,108 Cost of goods sold ............................. 3,778,838 3,514,575 3,439,863 Marketing, general and administrative .......... 22,213 22,396 21,412 ---------- ---------- ---------- Operating earnings ............................. 8,670 1,147 8,833 Interest ....................................... 4,807 8,144 8,701 Equity income from investments ................. (4,257) (4,519) (6,452) ---------- ---------- ---------- Income (loss) before income taxes .............. $ 8,120 $ (2,478) $ 6,584 ========== ========== ========== Total identifiable assets -- August 31 ......... $ 481,232 $ 345,696 $ 321,813 ========== ========== ==========
PROCESSED GRAINS AND FOODS OVERVIEW The Processed Grains and Foods business segment converts raw agricultural commodities into ingredients for finished food products or into finished consumer food products. The Company has focused on areas that allow it to utilize the products supplied by member producers. These areas are oilseed processing and refining, wheat milling and foods. OILSEED PROCESSING AND REFINING The Company's oilseed processing operations convert soybeans into soybean meal, soyflour, crude soyoil, refined soybean oil and associated by-products. These operations are conducted at a facility in Mankato, Minnesota that can crush 39 million bushels of soybeans on an annual basis, producing 9 approximately 940,000 short tons of soybean meal and 460 million pounds of crude soybean oil. The same facility is able to refine approximately 1 billion pounds of refined soybean oil annually. Another crushing facility is under construction in Fairmont, Minnesota that will have a crushing capacity and crude soyoil output similar to the Mankato facility. The facility in Fairmont is anticipated to be ready for the 2003 harvest and is estimated to cost approximately $90 million, of which approximately $23 million has been spent through August 31, 2002. The Company's oilseed processing and refining operations produce three primary products: refined oils, soybean meal and soyflour. Refined oils are used in processed foods, such as margarine, shortening, salad dressings and baked goods and, to a lesser extent for certain industrial uses for plastics, inks and paints. Soybean meal has a high protein content and is used for feeding livestock. Soyflour is used in the baking industry, as a milk replacement in animal feed and in industrial applications. The Company's soy processing facilities are located in areas with a strong production base of soybeans and end-user market for the meal and soyflour. The Company purchases virtually all of its soybeans from members. The oilseed crushing operations currently produce approximately 45% of the crude oil that the Company refines; it purchases the balance from outside suppliers. The Company's customers for refined oil are principally large food product companies located throughout the United States. However, over 50% of the customers are located in the Midwest due to lower freight costs and slightly higher profitability. The largest customer for refined oil products is Ventura Foods, LLC (Ventura Foods), in which the Company holds a 50% ownership interest and with which the Company has a long-term supply agreement to supply minimum quantities of edible soybean oils as long as the Company maintains a minimum 25.5% ownership interest and the price is comparative with other suppliers of the product. The Company's sales to Ventura Foods were $49.8 million in fiscal year 2002. The Company also sells soymeal to over 500 customers, primarily feed lots and feed mills in southern Minnesota; six of these customers accounted for approximately 61% of the soymeal sold. Land O'Lakes/Farmland Feeds, LLC accounts for 29% of soymeal sold and Commodity Specialists Company accounts for 10% of soymeal sold. The Company sells soyflour to customers in the baking industry both domestically and for export. The refined soybean products industry is highly competitive. Major industry competitors include ADM, Cargill, Ag Processing, Inc., and Bunge. These and other competitors have acquired other processors and have expanded existing plants, or are proposing to construct new plants, both domestically and internationally. Price, transportation costs, services and product quality drive competition. The Company estimates that it has a market share of approximately 6% to 8% of the domestic refined soybean oil market and less than 3% of the domestic soybean crushing capacity. Soybeans are a commodity and their price can fluctuate significantly depending on production levels, demand for the refined products, and other supply and demand factors. WHEAT MILLING In January 2002, the Company and Cargill formed Horizon Milling, LLC (Horizon Milling), in which the Company owns 24% and Cargill owns the remaining 76%. Horizon Milling is the largest U.S. wheat miller. Sales of wheat and durum by the Company to Horizon Milling during fiscal year 2002 were $114.4 million. The Company ceased operations at its Huron, Ohio mill prior to the formation of Horizon Milling and the Company's facility lease expired on September 30, 2002. The Company is currently dismantling and negotiating for the sale of the milling equipment. The Processed Grains and Foods business segment established an impairment of approximately $6.5 million on the equipment during the fourth quarter of fiscal year 2002. FOODS The Company has two primary areas of focus in the foods area: Ventura Foods, which produces oilseed based products such as margarine and salad dressing and which is 50% owned by the Company, and the production of Mexican foods such as tortillas, tortilla chips and entrees. 10 VENTURA FOODS. Ventura Foods manufactures, packages, distributes and markets bulk margarine, salad dressings, mayonnaise, salad oils, syrups, soup bases and sauces, many of which utilize soybean oil as a primary ingredient. Approximately 20% of Ventura Food's volume, based on sales revenues, comes from products for which Ventura Foods owns the brand, and the remainder comes from products that it produces for third parties. A variety of Ventura Food's product formulations and processes are proprietary to it or its customers. Ventura Foods is the largest manufacturer of margarine in the U.S. and is a major producer of many other products. Ventura Foods has 13 manufacturing and distribution locations across the United States. It sources its raw materials, which consists primarily of soybean oil, canola oil, cottonseed oil, peanut oil and various ingredients and supplies, from various national suppliers, including the Company's oilseed processing and refining operations. It sells the products it manufactures to third parties as a contract manufacturer, as well as directly to retailers, food distribution companies and large institutional food service companies. Ventura Foods' sales are approximately 65% in foodservice and the remainder split between retail and industrial customers who use edible oil products as ingredients in foods they manufacture for resale. Ventura Foods competes with a variety of large companies in the food manufacturing industry. Some of its major competitors are ADM, Cargill, Bunge, Unilever, ConAgra, ACH, Smuckers, Kraft, and CF Sauer. Ventura Foods was created in 1996 and at the time was owned 40% by the Company and 60% by Wilsey Foods, Inc., a majority owned subsidiary of Mitsui USA, Inc. In March 2000, Wilsey Foods, Inc. sold an additional 10% interest bringing the Company's total equity investment in Ventura Foods to 50%. The Company accounts for the Ventura Foods investment under the equity method of accounting. MEXICAN FOODS. Since June 2000, the Company has acquired three regional producers of Mexican foods. Through its Mexican foods operations, the Company manufactures, packages and distributes tortillas, tortilla chips and prepared frozen Mexican food products such as burritos and tamales. The Company sells these products under a variety of local and regional brand names and also produces private label products and co-packs for customers. The current operational focus is on integrating these disparate operations into a single business entity with consistent standards, systems and sales practices. The Company is also working to develop a national brand from its predominantly local and regional brand platforms. The tortilla and tortilla chip industry in the United States is comprised of a large number of small regional manufacturers and a few dominant manufacturers. The Company estimates that its Mexican foods operation has approximately a 1.5% share of the national tortilla market and less than a 1% share of the national tortilla chip market. On a national basis, the primary competitors are large chip and snack companies such as Frito Lay. 11 SUMMARY OPERATING RESULTS Summary operating results for the Processed Grains and Foods business segment for the fiscal years ended August 31, 2002, 2001 and 2000 are shown below:
2002 2001 2000 ----------- ----------- ----------- (DOLLARS IN THOUSANDS) Revenues: Net sales* .................................... $ 496,084 $ 662,726 $ 584,052 Patronage dividends ........................... 260 339 100 Other revenues ................................ (1,469) (238) (10) --------- --------- --------- 494,875 662,827 584,142 Cost of goods sold ............................. 457,538 619,184 547,234 Marketing, general and administrative .......... 36,930 44,870 21,462 --------- --------- --------- Operating earnings (losses) .................... 407 (1,227) 15,446 Interest ....................................... 9,514 13,026 9,851 Equity income from investments ................. (41,331) (35,505) (24,367) --------- --------- --------- Income before income taxes ..................... $ 32,224 $ 21,252 $ 29,962 ========= ========= ========= Total identifiable assets -- August 31 ......... $ 439,942 $ 430,871 $ 391,286 ========= ========= =========
------------------ * The sales decline in 2002 is primarily due to the formation of Horizon Milling. Since January 2002 the Company has accounted for the operating results of its milling operations under the equity method of accounting. Earnings from the Company's interest in Horizon Milling are included as part of equity income from investments. PRICE RISK AND HEDGING Depending on the terms and conditions of the particular contract, the Company incurs risks of carrying inventory, including risks related to price changes and performance (including delivery, quality, quantity and shipment period) whenever it enters into a commodity purchase commitment. The Company is exposed to risk of loss in the market value of positions held, consisting of inventory and purchase contracts at a fixed or partially fixed price in the event market prices decrease. The Company is also exposed to risk of loss on its fixed price or partially fixed price sales contracts in the event market prices increase. To reduce the price change risks associated with holding fixed price positions, the Company generally takes opposite and offsetting positions by entering into commodity futures contracts (either a straight futures contract or an options futures contract) on regulated commodity futures exchanges for grain, and regulated mercantile exchanges for refined products and crude oil. The crude oil and most of the grain and oilseed volume handled by the Company can be hedged. Some grains cannot be hedged because there are no futures for certain commodities. For those commodities, risk is managed through the use of forward sales and different pricing arrangements and to some extent cross-commodity futures hedging. While hedging activities reduce the risk of loss from changing market values of inventory, such activities also limit the gain potential which otherwise could result from changes in market prices of inventory. The Company's policy is to generally maintain hedged positions in grain. The Company's profitability from operations is primarily derived from margins on products sold and grain merchandised, not from hedging transactions. Hedging arrangements do not protect against nonperformance of a contract. When a futures contract is entered into, an initial margin deposit must be sent to the applicable exchange or broker. The amount of the deposit is set by the exchange and varies by commodity. If the market price of a short futures contract increases, then an additional margin deposit (maintenance margin) would be required. Similarly, if the price of a long futures contract decreases, a maintenance margin deposit would be required and sent to the applicable exchange. Subsequent price changes could require additional maintenance margins or could result in the return of maintenance margins. 12 At any one time inventory and purchase contracts for delivery to the Company may be substantial. The Company has risk management policies and procedures that include net position limits. It is defined by commodity and includes both trader and management limits. This policy, and computerized procedures in grain marketing operations, triggers a review by operations management when any trader is outside of position limits and also triggers review by senior management of the Company if operating areas are outside of position limits. A similar process is used in energy operations. The position limits are reviewed at least annually with management of the Company. The Company monitors current market conditions and may expand or reduce the purchasing program in response to changes in those conditions. In addition, certain purchase and sale contracts are subject to credit approvals and appropriate terms and conditions. EMPLOYEES As of August 31, 2002, CHS Cooperatives had approximately 6,750 full and part-time employees, which included approximately 550 employees of NCRA. Of that total, approximately 2,180 were employed in the Energy segment, 2,260 in the Country Operations segment (not including an estimated 720 seasonal and temporary employees), 390 in the Grain Marketing segment, 970 in the Processed Grains and Foods business segment and 230 in corporate and administrative functions. In addition to those employed directly by the Company, many employees work directly for the joint ventures in which the Company has an ownership interest. All of the employees in the Agronomy segment and a portion of the Grain Marketing and Processed Grains and Foods segments are employed as such. Employees in certain areas are represented by collective bargaining agreements. Refinery workers in Laurel, Montana (233 employees), are represented by agreements with two unions (Paper, Allied-Industrial, Chemical and Energy Workers International Union (PACE) and Oil Basin Pipeliners Union (OBP)), for which agreements are in place through 2006 for PACE and under negotiation for OBP with anticipation of a successful resolution. The contracts covering the McPherson, Kansas refinery (254 employees in the PACE union) are also in place through 2006. There are approximately 160 employees in transportation and lubricant plant operations that are covered by collective bargaining agreements that expire at various times. Production workers in grain marketing operations (143 employees) are represented by agreements with four unions which expire at various times from 2003 through 2005. Finally, certain production workers in Oilseed Processing and Refining operations are subject to collective bargaining agreements with the American Federation of Grain Millers (126 employees) and the Pipefitters' Union (2 employees). Both of these contracts have expired and are currently being negotiated with the Company anticipating a successful resolution. MEMBERSHIP IN THE COMPANY AND AUTHORIZED CAPITAL INTRODUCTION The Company is an agricultural membership cooperative organized under Minnesota cooperative law to do business with member and non-member patrons. Patrons, and not the Company, are subject to income taxes on income from patronage. The Company is subject to income taxes on non-patronage-sourced income. See "-- Tax Treatment" below. DISTRIBUTION OF NET INCOME; PATRONAGE DIVIDENDS The Company is required by its organizational documents annually to distribute net earnings derived from patronage business with members, after payment of dividends on equity capital, to members on the basis of patronage, except that the Board of Directors may elect to retain and add to the Company's unallocated capital reserve an amount not to exceed 10% of the distributable net income from patronage business. Net income from non-patronage business may be distributed to members or added to the unallocated capital reserve, in whatever proportions the Board of Directors deems appropriate. 13 These distributions, referred to as "patronage dividends," may be distributed in cash, patrons' equities, revolving fund certificates, securities of the Company or others or any combination designated by the Board of Directors. Since 1998, the Board of Directors has distributed patronage dividends in the form of 30% cash and 70% patrons' equities (see "-- Patrons' Equities" below). The Board of Directors may change the mix in the form of the patronage dividend in the future. In making distributions, the Board of Directors may use any method of allocation as may, in its judgment, be reasonable and equitable. Patronage dividends distributed during the years ended August 31, 2002, 2001 and 2000 were $132.6 million ($40.1 million in cash), $86.4 million ($26.1 million in cash) and $59.1 million($17.9 million in cash), respectively. PATRONS' EQUITIES Patrons' equities are in the form of a bookkeeping entry and represent a right to receive cash when redeemed by the Company. Patrons' equities form part of the capital of the Company, do not bear interest and are not subject to redemption upon request of a member. Patrons' equities are redeemable only at the discretion of the Board of Directors and in accordance with the terms of a redemption policy adopted by the Board of Directors, which may be modified at any time without member consent. The Company's current policy is to redeem the equities of those members who were age 61 and older on June 1, 1998 when they reach the age of 72 and upon death. The current policy is also to redeem equities older than 10 years held by active members on a pro-rata basis as determined by the Board of Directors. Redemptions of patrons' and other equities, including equity participation units (discussed in Note 9 to the Financial Statements), during the years ended August 31, 2002, 2001 and 2000 were $31.1 million, $33.0 million and $28.7 million, respectively. GOVERNANCE The Company is managed by a Board of Directors of at least 17 persons elected by the members at the Company's annual meeting. Terms of Directors are staggered so that no more than seven directors are elected in any year. The Board of Directors is currently comprised of 17 directors. The articles of incorporation and bylaws of the Company may be amended only upon approval of a majority of the votes cast at an annual or special meeting of the members, except for the higher vote described under "-- Certain Antitakeover Measures" below. MEMBERSHIP Membership in the Company is restricted to certain producers of agricultural products and to associations of producers of agricultural products that are organized and operating so as to adhere to the provisions of the Agricultural Marketing Act and the Capper-Volstead Act, as amended. The Board of Directors may establish other qualifications for membership as it may from time to time deem advisable. As a membership cooperative, the Company does not have common stock. The Company may issue equity or debt securities, on a patronage basis or otherwise, to its members. The Company has two classes of outstanding membership. Individual members are individuals actually engaged in the production of agricultural products. Cooperative associations are associations of agricultural producers, either cooperatives or other associations organized and operated under the provisions of the Agricultural Marketing Act and the Capper-Volstead Act. VOTING RIGHTS Voting rights arise by virtue of membership in the Company, not because of ownership of any equity or debt security. Members that are cooperative associations are entitled to vote based upon a formula that takes into account the number of producer members of such cooperative, the equity held by the cooperative in the Company and the average amount of business done with the Company over the previous three years. Members who are individuals are entitled to one vote. Individual members may exercise their voting power directly or through a patrons' association associated with a grain elevator, feed mill, seed plant or any other Company facility (with certain historical exceptions) recognized by the Board of Directors. The number of votes of patrons' associations is determined under the same formula as cooperative association members. 14 The Board of Directors has proposed an amendment to the Company's bylaws to eliminate the number of producers as a factor in determining the number of votes of cooperative association members and patrons' associations. The proposed amendment is expected to be voted upon at the annual members' meeting in December 2002. Most matters submitted to a vote of the members require the approval of a majority of the votes cast at a meeting of the members, although the approval of not less than two-thirds of the votes cast at a meeting is required to approve "Change of Control" transactions, which include a merger, consolidation, liquidation, dissolution, or the sale of all or substantially all of the Company's assets and, in certain circumstances, a greater vote may be required. See "Certain Antitakeover Measures" below. DEBT AND EQUITY INSTRUMENTS The Company may issue debt and equity instruments to its current members and patrons, on a patronage basis or otherwise, and to persons who are neither members nor patrons. Debt or equity issued by the Company is subject to a first lien in favor of the Company for all indebtedness of the holder thereof to the Company. As of August 31, 2002 the Company's outstanding capital included patrons' equities (consisting of capital equity certificates and non-patronage earnings certificates), 8% Preferred Stock and certain capital reserves. A best efforts offering of 8% Preferred Stock begun in late 2001 has been suspended after raising approximately $9.5 million in new capital. DISTRIBUTION OF ASSETS UPON DISSOLUTION; MERGER AND CONSOLIDATION In the event of any dissolution, liquidation or winding up of the Company, whether voluntary or involuntary, all debts and liabilities would be paid first according to their respective priorities. As more particularly provided in the Company's bylaws, the remaining assets would be paid to the holders of equity capital to the extent of their interests and any excess would be paid to patrons on the basis of their past patronage. The bylaws provide for the allocation among the members and nonmember patrons of the consideration received in any merger or consolidation to which the Company is a party. CERTAIN ANTITAKEOVER MEASURES The governing documents may be amended upon the approval of a majority of the votes cast at an annual or special meeting. However, if the Board of Directors, in its sole discretion, declares that a proposed amendment to the Company's governing documents involves or is related to a "hostile takeover," the amendment must be adopted by 80% of the total voting power of the members of the Company. Further, if the Board of Directors determines that a proposed change of control transaction involves a hostile takeover, the 80% approval requirement applies. The term "hostile takeover" is not further defined in the Minnesota cooperative law or the governing documents of the Company. TAX TREATMENT Subchapter T of the Internal Revenue Code sets forth rules for the tax treatment of cooperatives and applies to both cooperatives exempt from taxation under Section 521 of the Internal Revenue Code and to nonexempt corporations operating on a cooperative basis. The Company is a nonexempt cooperative. As a cooperative, the Company is not taxed on patronage paid to its members either in the form of equities or cash. Consequently, such amounts are taxed only at the patron level. However, the amounts of any allocated but undistributed patronage earnings (called non-qualified unit retains) are taxable to the Company when allocated. Upon redemption of any such non-qualified unit retains, the amount is deductible to the Company and taxable at the member level. Income derived by the Company from non-patronage sources is not entitled to the "single tax" benefit of Subchapter T and is taxed to the Company at corporate income tax rates. 15 ITEM 2. PROPERTIES The Company owns or leases energy, grain handling and processing, food manufacturing and agronomy related facilities throughout the United States. Below is a summary of these locations. ENERGY Facilities in the Company's Energy business segment include the following, all of which are owned except where indicated as leased: Refinery Laurel, Montana Propane Plants 10 locations in Iowa, Idaho, and Oregon Propane Terminals 3 locations in Minnesota, North Dakota and Wisconsin Transportation Terminals/Repair 10 locations in Iowa, Minnesota, Montana, North Dakota, South Facilities Dakota, Washington and Wisconsin, 2 of which are leased Petroleum & Asphalt 9 locations in Montana, North Dakota and Wisconsin Terminals/Storage Facilities Pump Stations 10 locations in Montana and North Dakota Pipelines: Cenex Pipeline, LLC Laurel, Montana to Fargo, North Dakota Front Range Pipeline, LLC Canadian Border to Laurel, Montana Convenience Stores/Gas 36 locations in Iowa, Minnesota, Montana, South Dakota and Stations Wyoming Lube Plants/Warehouses 3 locations in Minnesota, Ohio and Texas The Company has a 74.5% interest in NCRA, which operates the following facilities: Refinery McPherson, Kansas Petroleum Terminals/Storage 2 locations in Iowa and Kansas Pipeline McPherson, Kansas to Council Bluffs, Iowa Jayhawk Pipeline Throughout Kansas, with branches in Oklahoma and Texas Jayhawk Stations 40 locations located in Kansas and Oklahoma
GRAIN MARKETING The Company owns or leases grain terminals used in the Grain Marketing business segment at the following locations: Davenport, Iowa (2 owned terminals) Kalama, Washington (leased) Kansas City, Missouri (2 leased terminals) Myrtle Grove, Louisiana (owned) St. Paul, Minnesota (leased) Savage, Minnesota (owned) Spokane, Washington (owned) Superior, Wisconsin (owned) Winona, Minnesota (owned) COUNTRY OPERATIONS In the Country Operations business segment the Company owns approximately 300 Agri Operations locations (of which some of the facilities are on leased land), 7 feed manufacturing facilities and 2 sunflower plants (one was purchased in September 2002) located in Minnesota, Nebraska, North Dakota, South Dakota, Montana, Washington, Oregon and Idaho. 16 PROCESSED GRAINS AND FOODS Within the Processed Grains and Foods business segment, the Company owns and leases the following facilities: Oilseed Processing and Refining The Company owns a campus in Mankato, Minnesota, comprised of a crushing plant, an oilseed refinery, a soyflour plant and a quality control laboratory. A new crushing plant is currently under construction at Fairmont, Minnesota which the Company expects to complete in the fall of 2003. Wheat Milling The Company owns five flour milling facilities at the following locations that are leased to Horizon Milling, LLC: Rush City, Minnesota Kenosha, Wisconsin Houston, Texas Mount Pocono, Pennsylvania Fairmount, North Dakota Foods The Company leases manufacturing facilities in New Brighton, Minnesota and Phoenix, Arizona, and two facilities in Newton, North Carolina. In addition, the Company owns three manufacturing facilities in Ft. Worth, Texas. A new facility is currently under construction near Newton, North Carolina, which the Company expects to complete during its fiscal year ended August 31, 2003. All facilities are related to Mexican foods operations. CORPORATE HEADQUARTERS The Company is headquartered in Inver Grove Heights, Minnesota. The 33-acre campus consists of one main building with approximately 320,000 square feet of office space and two smaller buildings with approximately 13,400 and 9,000 square feet of space. ITEM 3. LEGAL PROCEEDINGS The Company is a party to various lawsuits and administrative proceedings incidental to its business. It is impossible at this time to estimate what the ultimate legal and financial liability of the Company will be; nevertheless, management believes, based on the information available to date and the resolution of prior proceedings, that the ultimate liability of all litigation and proceedings will not have a material impact on the financial position of the Company taken as a whole. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS None. 17 PART II. ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS The Company sold no equity securities during the three years ended August 31, 2002 that were not registered under the Securities Act of 1933, as amended. On August 31, 2002 the Company had 9,325,374 shares of 8% Preferred Stock outstanding. There is no active trading market for the Preferred Stock. ITEM 6. SELECTED FINANCIAL DATA The selected financial information below has been derived from the Company's consolidated financial statements for the periods indicated. The selected consolidated financial information subsequent to August 31, 1999 should be read in conjunction with the Company's consolidated financial statements and notes thereto included elsewhere in this filing. SUMMARY CONSOLIDATED FINANCIAL DATA
YEARS ENDED AUGUST 31, THREE MONTHS ------------------------------------------------------- ENDED AUGUST 31, YEAR ENDED 2002 2001 2000 1999 1998 MAY 31, 1998 ------------- ------------- ------------- ------------- ------------------ ------------- (DOLLARS IN THOUSANDS) Income Statement Data: Revenues: Net sales ................... $7,731,867 $7,753,012 $8,497,850 $6,381,334 $1,531,124 $8,410,030 Patronage dividends ......... 3,885 5,977 5,494 5,876 5,111 70,387 Other revenues .............. 109,459 116,254 97,471 81,180 17,706 85,127 ---------- ---------- ---------- ---------- ---------- ---------- 7,845,211 7,875,243 8,600,815 6,468,390 1,553,941 8,565,544 Cost of goods sold ............ 7,513,369 7,470,203 8,300,494 6,193,287 1,475,407 8,209,448 Marketing, general and administrative ............... 187,292 184,046 155,266 152,031 34,998 126,061 ---------- ---------- ---------- ---------- ---------- ---------- Operating earnings ............ 144,550 220,994 145,055 123,072 43,536 230,035 Interest ...................... 42,455 61,436 57,566 42,438 12,311 34,620 Equity (income) loss from investments .................. (58,133) (28,494) (28,325) (22,363) 9,142 (8,381) Minority interests ............ 15,390 35,098 24,546 10,017 3,252 6,880 ---------- ---------- ---------- ---------- ---------- ---------- Income before income taxes .... 144,838 152,954 91,268 92,980 18,831 196,916 Income taxes .................. 18,700 (25,600) 3,880 6,980 2,895 19,615 ---------- ---------- ---------- ---------- ---------- ---------- Net income .................... $ 126,138 $ 178,554 $ 87,388 $ 86,000 $ 15,936 $ 177,301 ========== ========== ========== ========== ========== ========== Balance Sheet Data (at end of period): Working capital ............... $ 249,115 $ 305,280 $ 214,223 $ 219,045 $ 284,452 $ 235,721 Net property, plant and equipment .................... 1,057,421 1,023,872 1,034,768 968,333 915,770 868,073 Total assets .................. 3,481,727 3,057,319 3,172,680 2,787,664 2,469,103 2,436,515 Long-term debt, including current maturities ........... 572,124 559,997 510,500 482,666 456,840 378,408 Total equities ................ 1,289,638 1,261,153 1,164,426 1,117,636 1,065,877 1,029,973
18 The selected financial statement information below has been derived from the Company's five business segments, and Corporate and Other, for the fiscal years ended August 31, 2002, 2001 and 2000. The intracompany sales between segments were $683.8 million, $782.5 million and $718.2 million for the fiscal years ended August 31, 2002, 2001 and 2000, respectively. SUMMARY FINANCIAL DATA BY BUSINESS SEGMENT
AGRONOMY ENERGY ----------------------------------------- ----------------------------------------- 2002 2001 2000 2002 2001 2000 ------------- ------------- ------------- ------------- ------------- ------------- (DOLLARS IN THOUSANDS) Revenues: Net sales ................................. $ 808,659 $2,657,689 $2,781,243 $2,959,622 Patronage dividends ....................... $ (89) $ 196 224 458 712 311 Other revenues ............................ 5,817 6,392 4,036 2,792 ---------- ---------- ---------- ---------- ---------- ---------- (89) 196 814,700 2,664,539 2,785,991 2,962,725 Cost of goods sold ......................... 764,744 2,489,352 2,549,099 2,862,715 Marketing, general and administrative ............................ 8,957 8,503 20,832 66,731 48,432 43,332 ---------- ---------- ---------- ---------- ---------- ---------- Operating (losses) earnings ................ (9,046) (8,307) 29,124 108,456 188,460 56,678 Interest ................................... (1,403) (4,529) (3,512) 16,875 25,097 27,926 Equity (income) loss from investments ............................... (13,425) (7,360) 4,336 1,166 4,081 (856) Minority interests ......................... 14,604 34,713 24,443 ---------- ---------- ---------- ---------- ---------- ---------- Income before income taxes ................. $ 5,782 $ 3,582 $ 28,300 $ 75,811 $ 124,569 $ 5,165 ========== ========== ========== ========== ========== ========== Total identifiable assets -- August 31 ..... $ 242,015 $ 230,051 $ 228,277 $1,305,828 $1,154,036 $1,379,019 ========== ========== ========== ========== ========== ========== COUNTRY OPERATIONS GRAIN MARKETING ----------------------------------------- ----------------------------------------- 2002 2001 2000 2002 2001 2000 ------------- ------------- ------------- ------------- ------------- ------------- (DOLLARS IN THOUSANDS) Revenues: Net sales ................................. $1,474,553 $1,577,268 $1,409,892 $3,787,322 $3,514,314 $3,453,807 Patronage dividends ....................... 2,572 3,683 3,830 497 840 861 Other revenues ............................ 80,789 80,479 68,436 21,902 22,964 15,440 ---------- ---------- ---------- ---------- ---------- ---------- 1,557,914 1,661,430 1,482,158 3,809,721 3,538,118 3,470,108 Cost of goods sold ......................... 1,471,422 1,569,884 1,404,120 3,778,838 3,514,575 3,439,863 Marketing, general and administrative ............................ 47,995 53,417 44,136 22,213 22,396 21,412 ---------- ---------- ---------- ---------- ---------- ---------- Operating earnings ......................... 38,497 38,129 33,902 8,670 1,147 8,833 Interest ................................... 13,851 15,695 12,782 4,807 8,144 8,701 Equity income from investments ............. (283) (246) (1,007) (4,257) (4,519) (6,452) Minority interests ......................... 786 385 103 ---------- ---------- ---------- ---------- ---------- ---------- Income (loss) before income taxes .......... $ 24,143 $ 22,295 $ 22,024 $ 8,120 $ (2,478) $ 6,584 ========== ========== ========== ========== ========== ========== Total identifiable assets -- August 31 ..... $ 799,711 $ 679,053 $ 660,358 $ 481,232 $ 345,696 $ 321,813 ========== ========== ========== ========== ========== ========== PROCESSED GRAINS AND FOODS CORPORATE AND OTHER ----------------------------------------- ----------------------------------------- 2002 2001 2000 2002 2001 2000 ------------- ------------- ------------- ------------- ------------- ------------- (DOLLARS IN THOUSANDS) Revenues: Net sales ................................. $ 496,084 $ 662,726 $ 584,052 Patronage dividends ....................... 260 339 100 $ 187 $ 207 $ 168 Other revenues ............................ (1,469) (238) (10) 1,845 9,013 4,996 ---------- ---------- ---------- ---------- ---------- ---------- 494,875 662,827 584,142 2,032 9,220 5,164 Cost of goods sold ......................... 457,538 619,184 547,234 Marketing, general and administrative ............................ 36,930 44,870 21,462 4,466 6,428 4,092 ---------- ---------- ---------- ---------- ---------- ---------- Operating earnings (losses) ................ 407 (1,227) 15,446 (2,434) 2,792 1,072 Interest ................................... 9,514 13,026 9,851 (1,189) 4,003 1,818 Equity (income) loss from investments ............................... (41,331) (35,505) (24,367) (3) 15,055 21 ---------- ---------- ---------- ---------- ---------- ---------- Income (loss) before income taxes .......... $ 32,224 $ 21,252 $ 29,962 $ (1,242) $ (16,266) $ (767) ========== ========== ========== ========== ========== ========== Total identifiable assets -- August 31 ..... $ 439,942 $ 430,871 $ 391,286 $ 212,999 $ 217,612 $ 191,927 ========== ========== ========== ========== ========== ==========
19 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Cenex Harvest States Cooperatives (CHS Cooperatives, CHS or the Company) is one of the nation's leading integrated agricultural companies. As a cooperative, the Company is owned by farmers, ranchers and their local cooperatives from the Great Lakes to the Pacific Northwest and from the Canadian border to Texas. CHS Cooperatives buys commodities from, and provides products and services to members and other customers. The Company provides a wide variety of products and services, from initial agricultural inputs such as fuels, farm supplies and crop nutrients, to agricultural outputs that include grains and oilseeds, grain and oilseed processing, and food products. The Company has five distinct business segments: Agronomy, Energy, Country Operations, Grain Marketing and Processed Grains and Foods. Summary data for each of these segments for the fiscal years ended August 31, 2002, 2001 and 2000 is shown on prior pages. Many of the Company's businesses are highly seasonal. Due to this, operating income will vary throughout the year, but overall revenues remain fairly constant, partly because the Company does not consolidate revenues in the Agronomy segment as explained below. Overall, the Company's income is generally lowest during the second fiscal quarter and highest during the third fiscal quarter. Certain business segments are subject to varying seasonal fluctuations. For example, Agronomy and Country Operations segments experience higher volumes and income during the spring planting season and in the fall, which corresponds to harvest. The Grain Marketing segment, as well, is somewhat subject to fluctuations in revenue and earnings based on producer harvests. The Company's Energy segment generally experiences higher revenues and profitability in certain operating areas, such as refined products, in the summer when gasoline and diesel usage is highest. Other energy products, such as propane, experience higher revenues and profitability during the winter heating season. While the Company's sales and operating income are derived from businesses and operations which are wholly-owned and majority-owned, a portion of business operations are conducted through companies in which the Company holds ownership interests of 50% or less. The Company accounts for these investments primarily using the equity method of accounting, wherein CHS Cooperatives records as equity income from investments its proportionate share of income or loss reported by the entity, without consolidating the revenues and expenses of the entity in the Company's consolidated statements of operations. These investments principally include the Company's 25% ownership in Agriliance, LLC (Agriliance), the 50% ownership in TEMCO, LLC, the 50% ownership in United Harvest, LLC, the 24% ownership in Horizon Milling, LLC (Horizon) and the 50% ownership in Ventura Foods, LLC (Ventura). RESULTS OF OPERATIONS COMPARISON OF THE YEARS ENDED AUGUST 31, 2002 AND 2001 NET INCOME. Consolidated net income for the year ended August 31, 2002 was $126.1 million compared to $178.6 million for the year ended August 31, 2001, which represents a $52.5 million (29%) decrease. This decrease in profitability is primarily attributable to a tax benefit of $34.2 million in the prior year and decreased earnings in the Company's Energy segment compared to the year ended August 31, 2001. NET SALES. Consolidated net sales of $7.7 billion for the year ended August 31, 2002 decreased $21.1 million compared to the year ended August 31, 2001. Energy net sales of $2.6 billion decreased $119.1 million (4%) during the year ended August 31, 2002 compared to the year ended August 31, 2001. Sales for the year ended August 31, 2002 and 2001 were $2,657.7 million and $2,781.2 million, respectively. The Company eliminated all intracompany sales from the Energy segment to the Country Operations segment of $67.4 million and $71.8 million for the years ended August 31, 2002 and 2001, respectively. Prior to December 31, 2000 the company consolidated the business activity of Cooperative Refining LLC (CRLLC), a refining joint venture into the Energy segment. The Company held a 58% interest in CRLLC, which was dissolved effective December 31, 2000. The decrease in Energy sales is primarily due to this dissolution. The decrease was partially offset by an increase in refined fuel sales that were not part of CRLLC, which consisted of a 49% increase in volume, which was partially offset by a sales price decrease of $0.21 per gallon 20 compared to the year ended August 31, 2001. The average sales price of propane decreased by $0.21 per gallon, which was partially offset by a volume increase of 28% compared to the year ended August 31, 2001. Refined fuels and propane volume increases were primarily a result of acquisitions, with the most substantial acquisition taking place in November 2001, when the Company purchased for $39.0 million, the wholesale energy business of Farmland Industries, Inc. (Farmland), as well as all interest in Country Energy, LLC a joint venture formerly with Farmland. Country Operations farm supply sales of $612.5 million decreased by $51.3 million (8%) during the year ended August 31, 2002 compared to the year ended August 31, 2001. The decrease is primarily due to a reduction in the average retail sales price of energy products compared to the prior year. Company-wide grain and oilseed net sales of $4.0 billion increased $315.7 million (8%) during the year ended August 31, 2002 compared to the year ended August 31, 2001. Sales for the year ended August 31, 2002 were $3,787.3 million and $862.0 million from Grain Marketing and Country Operations segments, respectively. Sales for the year ended August 31, 2001 were $3,514.3 million and $913.4 million from Grain Marketing and Country Operations segments, respectively. The Company eliminated all intracompany sales from the Country Operations segment to the Grain Marketing segment, of $615.8 million and $709.9 million, for the years ended August 31, 2002 and 2001, respectively. The net increase in sales was primarily due to an increase of $0.60 (20%) per bushel in the average sales price of all grain and oilseed marketed by the Company, which was partially offset by a decrease in grain volume of 9% compared to the prior year. Processed Grains and Foods segment net sales of $495.5 million decreased $166.4 million (25%) during the year ended August 31, 2002 compared to the year ended August 31, 2001. Intracompany sales between segments were eliminated. The decrease in sales is primarily due to the formation of Horizon, a wheat flour milling and processing joint venture that was formed in January 2002. After that date, the Company accounted for operating results of Horizon under the equity method of accounting. The Company has a 24% interest in Horizon, and Cargill, Incorporated (Cargill) has a 76% interest. The Company is leasing five mills and related equipment to Horizon. PATRONAGE DIVIDENDS. Patronage dividends received of $3.9 million decreased $2.1 million (35%) during the year ended August 31, 2002 compared to the year ended August 31, 2001, primarily due to reduced patronage dividends from cooperatives. OTHER REVENUES. Other revenues of $109.5 million decreased $6.8 million (6%) during the year ended August 31, 2002 compared to the year ended August 31, 2001. The most significant changes were within the Energy segment, and Corporate and Other compared to the prior year. COST OF GOODS SOLD. Cost of goods sold of $7.5 billion increased $43.2 million (1%) during the year ended August 31, 2002, compared to the year ended August 31, 2001. The cost of all grains and oilseed procured by the Company through its Grain Marketing and Country Operations segments increased 9% compared to the year ended August 31, 2001 primarily due to a $0.59 (20%) average cost per bushel increase, which was partially offset by a 9% decrease in volume. This increase was partially offset by decreases in cost of goods sold in the Processed Grains and Foods, Country Operations and Energy segments. Processed Grains and Foods segment cost of goods sold decreased by 26% compared to the year ended August 31, 2001, primarily due to the formation of Horizon, as previously described. Country Operations segment farm supply cost of goods sold decreased by 9% during the year ended August 31, 2002 compared to the prior year primarily due to the reduced cost of energy products. The Energy segment cost of goods sold decreased by 2% during the year ended August 31, 2002 compared to the prior year, primarily due to the dissolution of CRLLC, as previously discussed. However, the volumes of refined fuels that were not associated with the dissolution of CRLLC increased by 49%, which was partially offset by an average cost decrease of $0.18 per gallon compared to the year ended August 31, 2001. The average cost of propane decreased by $0.19 per gallon, which was partially offset by a 28% volume increase compared to the prior year. These volume increases were primarily the result of acquisitions. MARKETING, GENERAL AND ADMINISTRATIVE. Marketing, general and administrative expenses of $187.3 million for the year ended August 31, 2002 increased by $3.2 million (2%) compared to the year 21 ended August 31, 2001. The net increase is primarily due to additional expenses resulting from Energy segment acquisitions, which was partially offset by reduced expenses within the Processed Grains and Foods segment due to the formation of Horizon described earlier. INTEREST. Interest expense of $42.5 million for the year ended August 31, 2002 decreased by $19.0 million (31%) compared to the year ended August 31, 2001. The average level of short-term borrowings decreased 24% and the average short-term interest rate decreased 3.6% during the year ended August 31, 2002 compared to the prior year. The net decrease in interest expense from short-term borrowings was partially offset by an increase due to an additional $80.0 million of long-term debt from a private placement, of which $25.0 million and $55.0 million were issued in January and March 2001, respectively. EQUITY INCOME FROM INVESTMENTS. Equity income from investments of $58.1 million for the year ended August 31, 2002 increased by $29.6 million (104%) compared to the year ended August 31, 2001. The increase was primarily attributable to decreased losses from Corporate and Other technology investments of $15.1 million that was dissolved. In addition, earnings from Agronomy, and Processed Grains and Foods segments investments increased in fiscal year 2002 by $6.1 million and $5.8 million, respectively compared to the prior year. MINORITY INTERESTS. Minority interests of $15.4 million for the year ended August 31, 2002 decreased by $19.7 million (56%) compared to the year ended August 31, 2001. The change in minority interests during the year ended August 31, 2002 compared to the prior year was primarily a result of less profitable operations within the Company's majority-owned subsidiaries and the dissolution of CRLLC. Substantially all minority interests relate to National Cooperative Refinery Association (NCRA) an approximately 74.5% owned subsidiary. INCOME TAXES. Income tax expense of $18.7 million for the year ended August 31, 2002 compares to a tax benefit of $25.6 million for the year ended August 31, 2001, resulting in effective tax rates of a 12.9% expense and a 16.7% benefit, respectively. The federal and state statutory rate applied to nonpatronage business activity was 38.9% for the years ended August 31, 2002 and 2001. An income tax benefit of $34.2 million for the year ended August 31, 2001 resulted from a change in the tax rate applied to the Company's cumulative temporary differences between income for financial statement purposes and income used for tax reporting purposes. The Company's calculation of its patronage distribution using earnings for financial statement purposes rather than tax basis earnings prompted the rate change. The Company recorded income tax expense of $18.7 million for the year ended August 31, 2002, which compares to $8.6 million for the year ended August 31, 2001, exclusive of the $34.2 million benefit related to the change in patronage determination described above. The income taxes and effective tax rate vary each year based upon profitability and nonpatronage business activity during each of the comparable years. COMPARISON OF THE YEARS ENDED AUGUST 31, 2001 AND 2000 NET INCOME. The Company's consolidated net income of $178.6 million for the year ended August 31, 2001 represents a $91.2 million (104%) increase compared to the year ended August 31, 2000. This net increase in profitability is primarily attributable to an increase in income from the Company's Energy segment, which was partially offset by decreases from the Agronomy and Grain Marketing segments, and Corporate and Other. NET SALES. Consolidated net sales of $7.8 billion for the year ended August 31, 2001 represent a $744.8 million (9%) decrease compared to the year ended August 31, 2000. The Company did not record Agronomy sales during the year ended August 31, 2001 compared to sales of $768.4 million net of intracompany elimination of $40.3 million from the Agronomy segment to the Country Operations segment for the year ended August 31, 2000. During 2000, the Company exchanged its agronomy operations for an ownership interest in Agriliance, LLC, owned indirectly through United Country Brands, LLC. As of July 31, 2000, the Company recorded results of its 25% ownership in Agriliance, LLC on the equity method, and as such, income or losses are reflected in equity income from investments. 22 Energy net sales of $2.7 billion decreased $194.5 million (7%) during the year ended August 31, 2001 compared to the year ended August 31, 2000. Sales for the years ended August 31, 2001 and 2000 were $2,781.2 million and $2,959.6 million, respectively. The Company eliminated all intracompany sales from the Energy segment to the Country Operations segment of $71.8 million and $55.7 million for the years ended August 31, 2001 and 2000, respectively. The decrease is primarily attributable to a net volume decrease compared to the year ended August 31, 2000 due to the dissolution of CRLLC effective December 31, 2000. The Company owned 58% of CRLLC through its ownership in NCRA and therefore consolidated CRLLC business activity up to the time of dissolution. The decrease related to the dissolution was partially offset by an increase in refined fuels that were not part of CRLLC of $0.12 per gallon in the average sales price and 2% in volume compared to the year ended August 31, 2000. In addition, propane volumes increased by 39% and the average sales price of propane increased by $0.21 per gallon compared to the year ended August 31, 2000. Country Operations farm supply sales of $663.9 million increased $73.0 million (12%) for the year ended August 31, 2001 compared to the year ended August 31, 2000. The net increase is primarily attributable to average sales price increases in agronomy and energy products and additional volumes from acquisitions. Company-wide grain and oilseed net sales of $3.7 billion increased $67.0 million (2%) during the year ended August 31, 2001 compared to the year ended August 31, 2000. Sales for the year ended August 31, 2001 were $3,514.3 million and $913.4 million from Grain Marketing and Country Operations segments, respectively. Sales for the year ended August 31, 2000 were $3,453.8 million and $819.0 million from Grain Marketing and Country Operations segments, respectively. The Company eliminated all intracompany sales from the Country Operations segment to the Grain Marketing segment of $709.9 million and $622.0 million for the years ended August 31, 2001 and 2000, respectively. This increase in sales was primarily due to an increase of $0.06 (2%) per bushel in the average sales price while volumes were essentially unchanged on all grain and oilseed marketed by the Company compared to the prior year. Processed Grains and Foods segment net sales of $661.9 million increased $78.1 million (12%) for the year ended August 31, 2001 compared to the year ended August 31, 2000. Intracompany sales between segments were eliminated. This increase is primarily due to foods acquisitions, which increased sales by $47.3 million compared to the prior year. In addition, sales of processed wheat increased by $22.6 million compared to the prior year, primarily due to increased volumes from the acquisition of a wheat mill in April 2000 and an increase in the average sales price of all wheat products. Sales of processed oilseed increased by $8.8 million primarily due to volume and price increases compared to the prior year. OTHER REVENUES. Other revenues of $116.3 million increased $18.8 million (19%) for the year ended August 31, 2001 compared to the year ended August 31, 2000. The most significant increases were within the Country Operations and Grain Marketing segments. These increases were partially offset by a prior year gain of $7.4 million from the sale of 1.455% of the Company's economic interest in Agriliance, LLC which was recorded in March 2000 in the Agronomy segment. COST OF GOODS SOLD. Cost of goods sold of $7.5 billion decreased $830.3 million (10%) during the year ended August 31, 2001 compared to the year ended August 31, 2000. The decrease was primarily attributable to the impact of recording the Company's share of its agronomy operations on the equity method in 2001 as previously discussed, which caused a reduction in cost of goods sold of $764.7 million compared to the year ended August 31, 2000. In addition, during the year ended August 31, 2001 the cost of goods sold of the Energy segment decreased by 11% primarily due to a decrease in volume as a result of the dissolution of CRLLC. The decrease was partially offset by volume and price increases on refined fuels purchases that were not part of CRLLC, and propane products. The cost of all grain and oilseed procured by the Company through its Grain Marketing and Country Operations segments increased 2% compared to the previous year end primarily due to a $0.06 (2%) cost per bushel increase with volumes remaining essentially unchanged. Country Operations segment farm supply cost of goods sold increased by 14% during the year ended August 31, 2001 compared to the year ended August 31, 2000, primarily due to cost increases in agronomy and energy products and higher volumes due to acquisitions. Cost of goods sold within the Processed Grains and Foods segment increased by 13% due to volume increases primarily as a result of acquisitions. 23 MARKETING, GENERAL AND ADMINISTRATIVE. Marketing, general and administrative expenses of $184.0 million for the year ended August 31, 2001 increased by $28.7 million (19%) compared to the year ended August 31, 2000. This increase is primarily due to increases in expenses within the Processed Grains and Foods segment of $23.4 million, which is primarily due to additional expenses of $12.9 million related to acquisitions and a loss on assets held for disposal of $7.5 million related to the closing of a wheat mill compared to the prior year. In addition, expenses within the Country Operations segment increased by $9.3 million primarily due to acquisitions. These increases were partially offset by a decrease in expenses of $12.3 million in the Agronomy segment. INTEREST. Interest expense of $61.4 million for the year ended August 31, 2001 increased by $3.8 million (7%) compared to the year ended August 31, 2000. The average level of short-term borrowings increased 11% and the average short-term interest rate decreased 0.55% during the year ended August 31, 2001 compared to the previous year. Interest expense also increased due to an additional $80.0 million of long-term debt from a private placement of which $25.0 million and $55.0 million were issued in January and March 2001, respectively. EQUITY INCOME FROM INVESTMENTS. Equity income from investments of $28.5 million for the year ended August 31, 2001 increased by $0.2 million (1%) compared to the year ended August 31, 2000. The increase was primarily attributable to increases in earnings from investments within the Agronomy and Processed Grains and Foods segments of $11.7 million and $11.1 million, respectively, during the year ended August 31, 2001 compared to the prior year. The Company records its 25% share of its Agronomy segment investment in Agriliance, LLC on the equity method as previously discussed. The net increase was partially offset by losses from technology investments of $15.1 million and decreased earnings of $4.9 million and $1.9 million from Energy and Grain Marketing segment investments, respectively. MINORITY INTERESTS. Minority interests of $35.1 million for the year ended August 31, 2001 increased by $10.6 million (43%) compared to the year ended August 31, 2000. Substantially all minority interests were related to NCRA. This net change in minority interests was reflective of more profitable operations within the Company's majority-owned subsidiaries during the year ended August 31, 2001 compared to the previous year. INCOME TAXES. An income tax benefit of $25.6 million for the year ended August 31, 2001 compares to expense of $3.9 million for the year ended August 31, 2000 resulting in effective tax rates of 16.7% benefit and 4.3% expense, respectively. The federal and state statutory rate applied to nonpatronage business activity was 38.9% for the years ended August 31, 2001 and 2000. An income tax benefit of $34.2 million for the year ended August 31, 2001 resulted from a change in the tax rate applied to the Company's cumulative temporary differences between income for financial statement purposes and income used for tax reporting purposes. The Company's change in the calculation of its patronage distribution using earnings for financial statement purposes rather than tax basis earnings prompted the rate change. The Company recorded an income tax expense of $8.6 million and $3.9 million for the years ended August 31, 2001 and 2000 excluding the effects of the adjustment. The income taxes and effective tax rates vary each year based upon profitability and nonpatronage business activity during each of the comparable years. LIQUIDITY AND CAPITAL RESOURCES CASH FLOWS FROM OPERATIONS Operating activities of the Company used net cash of $41.7 million during the year ended August 31, 2002. Net income of $126.1 million and net non-cash expenses of $62.4 million were offset by increased working capital requirements of $230.2 million. This increase in working capital requirements is primarily due to stronger commodity prices. Operating activities of the Company provided net cash of $252.8 million during the year ended August 31, 2001. Net income of $178.6 million, net non-cash expenses of $50.5 million and decreased working capital requirements of $23.7 million provided this net cash from operating activities. Operating activities of the Company provided net cash of $128.4 million during the year ended August 31, 2000. Net income of $87.4 million and net non-cash expenses of $79.7 million were partially offset by increased working capital requirements of $38.7 million. 24 CASH FLOWS FROM INVESTING ACTIVITIES For the years ended August 31, 2002, 2001 and 2000, the net cash flows used in the Company's investing activities totaled $141.8 million, $69.1 million and $184.9 million, respectively. The acquisition of property, plant and equipment comprised the primary use of cash totaling $140.2 million, $97.6 million and $153.8 million for the years ended August 31, 2002, 2001 and 2000, respectively. For the year ended August 31, 2003 the Company expects to spend approximately $216.8 million for the acquisition of property, plant and equipment, which includes $57.0 million of expenditures for the construction of an oilseed processing facility in Fairmont, Minnesota. Total expenditures related to the construction of the facility are projected to be approximately $90.0 million, of which $22.9 million was used for construction through the year ended August 31, 2002. Capital expenditures primarily related to the Environmental Protection Agency low sulfur fuel regulations required by 2006, are expected to be approximately $340 million in total for the Company's Laurel, Montana and NCRA's McPherson, Kansas refineries over the next four years. It is expected that over 80% of the costs will be incurred at NCRA. Investments made during the years ended August 31, 2002, 2001 and 2000 totaled $6.2 million, $14.2 million and $35.3 million, respectively. Investments during the year ended August 31, 2000 included the purchase of an additional 10% interest in Ventura Foods, LLC, the Company's foods joint venture, for $25.6 million. The Company has a 50% interest in that joint venture. Acquisitions of intangibles were $29.5 million, $7.3 million and $26.5 million for the years ended August 31, 2002, 2001 and 2000, respectively. During the year ended August 31, 2002, $26.4 million of the acquisitions of intangibles were related to the purchase of Farmland's interest in its wholesale energy business, as previously discussed, and represents trademarks, tradenames and non-compete agreements. During the previous two years, the intangibles resulted primarily from the purchase of Rodriguez Festive Foods, Inc. in fiscal 2001 and the purchase of Sparta Foods, Inc. and the wholesale propane marketing business of Williams Energy Marketing and Trading Company in fiscal 2000. During the year ended August 31, 2002 the changes in notes receivable resulted in a decrease of $22.0 million primarily from related party notes receivables at NCRA from its minority owners, Growmark, Inc. and MFA Oil Company. During the years ended August 31, 2001 and 2000 the changes in notes receivable resulted in increases of $0.5 million and $0.6 million, respectively. Distributions to minority owners for the years ended August 31, 2002, 2001 and 2000 were $7.4 million, $19.3 million and $21.1 million, respectively, and were primarily related to NCRA. For the years ended August 31, 2001 and 2000, NCRA's distributions also included the distributions made by CRLLC. Partially offsetting cash outlays in investing activities were proceeds from the disposition of property, plant and equipment of $20.2 million, $35.3 million and $7.7 million for the years ended August 31, 2002, 2001 and 2000, respectively. During the year ended August 31, 2002, the proceeds were primarily from disposals of propane plants in the Energy segment and of non-strategic agri-operations locations in the Country Operations segment. During the year ended August 31, 2001, the proceeds were primarily from the disposal of feed plants and other assets in the Country Operations segment. Also partially offsetting cash usages were distributions received from joint ventures and investments totaling $44.0 million, $31.8 million and $43.9 million for the years ended August 31, 2002, 2001 and 2000, respectively. CASH FLOWS FROM FINANCING ACTIVITIES The Company finances its working capital needs through short-term lines of credit with a syndication of banks. In May 2002, the Company renewed its 364-day credit facility of $550.0 million committed. In addition to these lines of credit, the Company has a 364-day credit facility dedicated to NCRA, with a syndication of banks in the amount of $30.0 million committed. On August 31, 2002 and 2001, the Company had total short-term indebtedness outstanding on these various facilities and other short-term notes payable totaling $332.5 million and $97.2 million, respectively. The increase from 2001 to 2002 is primarily due to increases in inventories in the Grain Marketing and Energy segments related to higher grain prices and the purchase of Farmland's wholesale energy business, discussed previously. 25 In June 1998, the Company established a five-year revolving credit facility with a syndication of banks, with $200.0 million committed. On August 31, 2002 and 2001 the Company had outstanding balances on this facility of $75.0 million and $45.0 million, respectively. The outstanding balance on August 31, 2002 includes $30.0 million, which was drawn during the first quarter of the fiscal year. The Company has financed its long-term capital needs in the past, primarily for the acquisition of property, plant and equipment, with long-term agreements through the banks for cooperatives. In June 1998, the Company established a long-term credit agreement through the banks for cooperatives. This facility committed $200.0 million of long-term borrowing capacity to the Company, with repayments through fiscal year 2009. The amount outstanding on this credit facility was $144.3 million and $150.9 million on August 31, 2002 and 2001, respectively. Repayments of $6.6 million were made on this facility during each of the years ended August 31, 2002 and 2001. Also in June 1998, the Company issued a private placement with several insurance companies for long-term debt in the amount of $225.0 million. Repayments will be made in equal annual installments of $37.5 million each in the years 2008 through 2013. In January 2001, the Company entered into a note purchase and private shelf agreement with Prudential Insurance Company. The long-term note in the amount of $25.0 million will be repaid in equal annual installments of approximately $3.6 million, in the years 2005 through 2011. A subsequent note for $55.0 million was issued in March 2001, related to the private shelf facility. The $55.0 million note will be repaid in equal annual installments of approximately $7.9 million, in the years 2005 through 2011. The Company, through NCRA, had revolving term loans outstanding of $18.0 million and $21.0 million for the years ended August 31, 2002 and 2001, respectively. Repayments of $3.0 million were made during each of the years ended August 31, 2002 and 2001. On August 31, 2002, the Company had total long-term debt outstanding of $572.1 million, of which $255.0 million was bank financing, $305.0 million was private placement proceeds and $12.1 million was industrial development revenue bonds, capitalized leases and other notes and contracts payable. On August 31, 2001, the Company had long-term debt outstanding of $560.0 million. The aggregate amount of long-term debt payable as of August 31, 2002 was as follows (dollars in thousands): 2002 ............... $ 89,032 2003 ............... 15,079 2004 ............... 34,511 2005 ............... 34,938 2006 ............... 41,709 Thereafter ......... 356,855 -------- $572,124 ======== During the years ended August 31, 2002, 2001 and 2000, the Company borrowed on a long-term basis $30.0 million, $116.9 million and $49.9 million, respectively, and during the same periods repaid long-term debt of $18.0 million, $67.4 million and $22.5 million, respectively. On October 18, 2002 (fiscal year 2003) the Company entered into a private placement with several insurance companies for long-term debt in the amount of $175.0 million which was layered into two series. The first series of $115.0 million has an interest rate of 4.96% and will be repaid in equal semi-annual installments of approximately $8.8 million during the years 2007 through 2013. The second series of $60.0 million has an interest rate of 5.60% and will be repaid in equal semi-annual installments of approximately $4.6 million during fiscal years 2012 through 2018. In accordance with the bylaws and by action of the Board of Directors, annual net earnings from patronage sources are distributed to consenting patrons following the close of each fiscal year. Effective September 1, 2000, patronage refunds are calculated based on earnings for financial statement purposes rather than based on amounts reportable for federal income tax purposes as had been the Company's practice prior to this date. This change was authorized through a bylaw amendment at the Company's annual meeting on December 1, 2000. The patronage earnings from the fiscal year ended August 31, 26 2001 were distributed in January 2002. The cash portion of this distribution, deemed by the Board of Directors to be 30% was $40.1 million. During the years ended August 31, 2001 and 2000, the Company distributed cash patronage of $26.1 million and $17.9 million, respectively. Cash patronage for the year ended August 31, 2002, deemed by the Board of Directors to be 30% and to be distributed in fiscal year 2003, is expected to be approximately $27.9 million and is classified as a current liability on the August 31, 2002 consolidated balance sheet. The current equity redemption policy, as authorized by the Board of Directors, allows for the redemption of capital equity certificates held by inactive direct members and patrons and active direct members and patrons at age 72 or death that were of age 61 or older on June 1, 1998. For active direct members and patrons who were of age 60 or younger on June 1, 1998, and member cooperatives, equities older than 10 years will be redeemed annually based on a prorata formula where the numerator is dollars available for such purpose as determined by the Board of Directors, and the denominator is the sum of the patronage certificates older than 10 years held by such eligible members and patrons. For the years ended August 31, 2002, 2001 and 2000, the Company redeemed patronage related equities in accordance with authorization from the Board of Directors in the amounts of $31.1 million, $18.7 million and $28.7 million, respectively. Total redemptions related to the year ended August 31, 2002, to be distributed in fiscal year 2003, are expected to be approximately $28.6 million and are classified as a current liability on the August 31, 2002 consolidated balance sheet. During the year ended May 31, 1997, the Company offered securities in the form of Equity Participation Units (EPUs) in its Wheat Milling and Oilseed Processing and Refining Defined Business Units. These EPUs gave the holder the right and obligation to deliver to the Company a stated number of bushels in return for a prorata share of the undiluted grain based patronage earnings of these respective Defined Business Units. The offering resulted in the issuance of such equity with a stated value of $13,870,000 and generated additional capital and cash of $10,837,000, after issuance cost and conversion privileges. Conversion privileges allowed a member to elect to use outstanding patrons' equities for the payment of up to one-sixth the purchase price of the EPUs. During 2001, the Company's Board of Directors adopted a resolution to issue, at no charge, to each Defined Member of the Oilseed Processing and Refining Defined Business Unit an additional 1/4 Equity Participation Unit (EPU) for each EPU held, due to increased crush volume. In August 2001, the CHS Cooperatives Board of Directors approved and consummated a plan to end the Defined Investment Program. The Company redeemed all of the EPUs and allocated the assets of the Oilseed Processing and Refining and Wheat Milling Defined Business Units to the Company as provided in the plan. Due to loss carry-forwards incurred by the Wheat Milling Defined Business Unit the plan also provided for the cancellation of all outstanding Preferred Capital Certificates issued to the EPU holders, totaling $0.2 million. The plan further provided to the Oilseed Processing Defined Member EPU holders for the redemption of all outstanding Preferred Capital Certificates issued and a 100% cash distribution during 2002 for the patronage refunds earned for the fiscal year ended August 31, 2001. The Board of Directors authorized the sale and issuance of up to 50,000,000 shares of 8% Preferred Stock at a price of $1.00 per share. The Company filed a registration statement on Form S-2 with the Securities and Exchange Commission registering the Preferred Stock. The registration statement was declared effective on October 31, 2001 and sales of the Preferred Stock were $9.3 million through August 31, 2002. Expenses related to the issuance of the Preferred Stock were $3.4 million through the same period. Sales of the preferred shares have been suspended. OFF BALANCE SHEET FINANCING ARRANGEMENTS LEASE COMMITMENTS: The Company has commitments under operating leases for various refinery, manufacturing and transportation equipment, rail cars, vehicles and office space. Some leases include purchase options at not less than fair market value at the end of the leases. Total rental expense for all operating leases, net of rail car mileage credits received from the railroad and sublease income for the years ended August 31, 2002, 2001 an 2000 was $30.2 million, $35.5 million and $38.0 million, respectively. 27 Minimum future lease payments, required under noncancellable operating leases as of August 31, 2002, were as follows: TOTAL ---------------------- (DOLLARS IN MILLIONS) 2003 ..................... $ 33.0 2004 ..................... 24.2 2005 ..................... 16.0 2006 ..................... 8.9 2007 ..................... 5.1 Thereafter ............... 4.8 ------- Total minimum future lease payments ................. $ 92.0 ======= GUARANTEES: The Company is a guarantor for lines of credit for related companies totaling up to $86.2 million, of which $45.1 million was outstanding as of August 31, 2002. The Company's bank covenants allow maximum guarantees of $100.0 million. All outstanding loans with respective creditors are current as of August 31, 2002. DEBT: There is no material off balance sheet debt. CRITICAL ACCOUNTING POLICIES The consolidated financial statements of the Company are prepared in conformity with accounting principles generally accepted in the United States of America. The preparation of these consolidated financial statements requires the use of estimates as well as management's judgments and assumptions regarding matters that are subjective, uncertain or involve a high degree of complexity, all of which affect the results of operations and financial condition for the periods presented. The Company believes that of its significant accounting policies, the following may involve a higher degree of estimates, judgments, and complexity. ALLOWANCES FOR DOUBTFUL ACCOUNTS The allowances for doubtful accounts are maintained at a level considered appropriate by management based on analyses of credit quality for specific accounts, historical trends of charge-offs and recoveries, and current and projected economic and market conditions. Different assumptions, changes in economic circumstances or the deterioration of the financial condition of the Company's customers could result in additional provisions to the allowances for doubtful accounts and increased bad debt expense. INVENTORY VALUATION AND RESERVES Grain, processed grain, oilseed and processed oilseed are stated at net realizable values, which approximates market values. All other inventories are stated at the lower of cost or market. The cost of certain energy inventories (wholesale refined products, crude oil and asphalt) are determined on the last-in, first-out (LIFO) method; all other energy inventories are valued on the first-in, first-out (FIFO) and average cost methods. Estimates are used in determining the net realizable value of grain and oilseed and processed grain and oilseed inventories. These estimates include the measurement of grain in bins and other storage facilities, which use formulas in addition to actual measurements taken to arrive at appropriate quantity. Other determinations made by management include quality of the inventory and estimates for freight. Grain shrink reserves and other reserves that account for spoilage also affect inventory valuation. If estimates regarding the valuation of inventory or the adequacy of reserves are less favorable than management's assumptions, then additional reserves or write-downs of inventory may be required. DERIVATIVE FINANCIAL INSTRUMENTS The Company enters into exchange-traded commodity futures and options contracts to hedge its exposure to price fluctuations on energy, grain and oilseed transactions to the extent considered 28 practicable for minimizing risk. The Company does not use derivatives for speculative purposes. Futures and options contracts used for hedging are purchased and sold through regulated commodity exchanges. Fluctuations in inventory valuations, however, may not be completely hedged, due in part to the absence of satisfactory hedging facilities for certain commodities and geographical areas and in part to the Company's assessment of its exposure from expected price fluctuations. The Company also manages its risks by entering into fixed price purchase contracts with pre-approved producers and establishing appropriate limits for individual suppliers. Fixed price sales contracts are entered into with customers of acceptable creditworthiness, as internally evaluated. The Company is exposed to loss in the event of nonperformance by the counterparties to the contracts. However, the Company does not anticipate nonperformance by counterparties. The fair value of futures and options contracts are determined primarily from quotes listed on regulated commodity exchanges. Fixed price purchase and sales contracts are with various counterparties, and the fair values of such contracts are determined from the market price of the underlying product. The Company adopted Financial Accounting Standards Board (FASB) Statement of Financial Accounting Standards (SFAS) No. 133, as amended, a standard related to the accounting for derivative transactions and hedging activities, effective September 1, 2000. Such accounting is complex, evidenced by significant interpretations of the primary accounting standard, which continues to evolve. PENSION AND POSTRETIREMENT BENEFITS Pension and other postretirement benefits costs and obligations are dependent on assumptions used in calculating such amounts. These assumptions include discount rates, health care cost trend rates, benefits earned, interest cost, expected return on plan assets, mortality rates, and other factors. In accordance with accounting principles generally accepted in the United States of America, actual results that differ from the assumptions are accumulated and amortized over future periods and, therefore, generally affect recognized expense and the recorded obligation in future periods. While management believes that the assumptions used are appropriate, differences in actual experience or changes in assumptions may affect the Company's pension and other postretirement obligations and future expense. DEFERRED TAX ASSETS The Company assesses whether a valuation allowance is necessary to reduce its deferred tax assets to the amount that it believes is more likely than not to be realized. While the Company has considered future taxable income as well as other factors in assessing the need for the valuation allowance, in the event that the Company were to determine that it would not be able to realize all or part of its net deferred tax assets in the future, an adjustment to the deferred tax assets would be charged to income in the period such determination was made. LONG-LIVED ASSETS Depreciation and amortization of the Company's property, plant and equipment is provided on the straight-line method by charges to operations at rates based upon the expected useful lives of individual or groups of assets. Economic circumstances or other factors may cause management's estimates of expected useful lives to differ from actual. All long-lived assets, including property plant and equipment, goodwill, investments in unconsolidated affiliates and other identifiable intangibles, are evaluated for impairment on the basis of undiscounted cash flows at least annually for goodwill, and whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. An impaired asset is written down to its estimated fair market value based on the best information available. Estimated fair market value is generally measured by discounting estimated future cash flows. Considerable management judgment is necessary to estimate discounted future cash flows and may differ from actual. ENVIRONMENTAL LIABILITIES Liabilities related to remediation of contaminated properties are recognized when the related costs are considered probable and can be reasonably estimated. Estimates of these costs are based on current available facts, existing technology, undiscounted site-specific costs and currently enacted laws and regulations. Recoveries, if any, are recorded in the period in which recovery is considered probable. It is 29 often difficult to estimate the cost of environmental compliance, remediation and potential claims given the uncertainties regarding the interpretation and enforcement of applicable environmental laws and regulations, the extent of environmental contamination and the existence of alternate cleanup methods. All liabilities are monitored and adjusted as new facts or changes in law or technology occur and management believes adequate provisions have been made for environmental liabilities. Changes in facts or circumstances may have an adverse impact on the Company's financial results. EFFECT OF INFLATION AND FOREIGN CURRENCY TRANSACTIONS The Company believes that inflation and foreign currency fluctuations have not had a significant effect on its operations. RECENT ACCOUNTING PRONOUNCEMENTS Effective September 1, 2001 the Company adopted the provisions of Financial Accounting Standards Board (FASB) Statement of Financial Accounting Standards (SFAS) No. 142, "Goodwill and Other Intangible Assets". The adoption of this pronouncement did not have a material impact on the Company's consolidated financial statements. The FASB issued SFAS No. 143, "Accounting for Asset Retirement Obligations" which addresses financial accounting and reporting for obligations associated with the retirement of tangible long-lived assets and the associated asset retirement costs. SFAS No. 143 is effective for financial statements issued for fiscal years beginning after June 15, 2002. The adoption of this statement does not have a material affect on the Company. The FASB also issued SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets." This statement addresses financial accounting and reporting for the impairment or disposal of long-lived assets. SFAS No. 144 retains and expands upon the fundamental provisions of existing guidance related to the recognition and measurement of the impairment of long-lived assets to be held and used and the measurement of long-lived assets to be disposed of by sale. Generally, the provisions of SFAS No. 144 are effective for financial statements issued for fiscal years beginning after December 15, 2001 and interim periods within those fiscal years. The adoption of this statement does not have a material affect on the Company. The FASB issued SFAS No. 146, "Accounting for Costs Associated with Exit or Disposal Activities". This statement addresses financial accounting and reporting for costs associated with an exit activity that does not involve an entity newly acquired in a business combination or with a disposal activity covered by SFAS No. 144. The costs addressed in SFAS No. 146 include, but are not limited to, termination benefits, costs to terminate a contract that is not a capital lease and costs to consolidate facilities or relocate employees. SFAS No. 146 is effective for exit or disposal activities that are initiated after December 31, 2002. ITEM 7(A). QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK COMMODITY PRICE RISK The Company utilizes futures and options contracts offered through regulated commodity exchanges to reduce risk. The Company is exposed to risk of loss in the market value of inventories and fixed or partially fixed purchase and sales contracts. So as to reduce that risk, the Company generally takes opposite and offsetting positions using futures contracts or options. Certain commodities cannot be hedged with futures or options contracts because such contracts are not offered for these commodities by regulated commodity exchanges. Inventories and purchase contracts for those commodities are hedged with forward sales contracts to the extent practical so as to arrive at a net commodity position within the formal position limits set by the Company and deemed prudent for each of those commodities. Commodities for which futures contracts and options are available are also typically hedged first in this manner, with futures and options used to hedge within position limits that portion not covered by forward contracts. These futures and options contracts and forward purchase and sales cash contracts used to hedge against price level change risks are effective economic hedges of specified risks, but they are not designated as and accounted for as hedging instruments for accounting purposes. 30 Unrealized gains and losses on futures contracts and options used as economic hedges of grain and oilseed inventories and fixed price contracts are recognized in cost of goods sold for financial reporting. Inventories and fixed price contracts are marked to market so that gains or losses on the derivative contracts are offset by gains or losses on inventories and fixed priced contracts during the same accounting period. Through August 31, 2000, unrealized gains and losses on futures contracts and options used to hedge energy inventories and fixed price contracts were deferred until such futures contracts and options were closed. Effective September 1, 2000 those gains and losses are recognized as a component of net income for financial reporting. The inventories hedged with these derivatives are valued at lower of cost or market, and effective September 1, 2000, the fixed price contracts are marked to market. Some derivatives related to propane in the Energy segment meet the normal purchase and sales exemption, and thus are not required to be marked to fair value. A 10% adverse change in market prices would not materially affect the Company's results of operations, financial position or liquidity, since the Company's operations have effective economic hedging requirements as a general business practice. INTEREST RATE RISK The Company manages interest expense using a mix of fixed and floating rate debt. These debt instruments are carried at amounts approximating estimated fair value. Short-term debt used to finance inventories and receivables is represented by notes payable within thirty days or less so that the blended interest rate to the Company for all such notes approximates current market rates. Long-term debt used to finance non-current assets carries various fixed interest rates and is payable at various dates as to minimize the effect of market interest rate changes. The effective interest rate to the Company on fixed rate debt outstanding on August 31, 2002 was approximately 6.4%; a 10% adverse change in market rates would not materially affect the Company's results of operations, financial position or liquidity. In August 2002, the Company entered into interest rate swap instruments related to private placement debt issued on October 18, 2002 in order to protect against a potential increase in interest rates. In fact, interest rates declined between the dates of the interest swaps and the closing of the borrowing transaction. These derivative instruments are designated and effective as cash flow hedges for accounting purposes and the changes in fair values of these instruments are recorded as a component of other comprehensive income. The Company expects to record additional interest expense of $0.8 million during the year ended August 31, 2003 related to these derivative instruments as an offset to the lower interest rates actually obtained on the debt instruments. FOREIGN CURRENCY RISK The Company conducts essentially all of its business in U.S. dollars and had essentially no risk regarding foreign currency fluctuations on August 31, 2002. Foreign currency fluctuations do, however, impact the ability of foreign buyers to purchase U.S. agricultural products and the competitiveness of U.S. agricultural products compared to the same products offered by alternative sources of world supply. ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA The financial statements listed in 15(a)(1) are set forth beginning on page F-1. The Company is not required to provide the supplementary financial information required by Item 302 of Regulation S-K in this Annual Report on Form 10-K. Financial statement schedules are omitted because they are not applicable or the required information is shown in the financial statements or notes thereto. ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None. 31 PART III. ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT BOARD OF DIRECTORS The table below lists the directors of the Company as of August 31, 2002. DIRECTOR NAME AND ADDRESS AGE DISTRICT SINCE ------------------------------------- ----- ---------- ------ Bruce Anderson 50 3 1995 13500 42nd St NE Glenburn, ND 58740-9564 Robert Bass 48 5 1994 E 639 -- 1 Bass Road Reedsburg, WI 53959 Steven Burnet 62 6 1983 94699 Monkland Lane Moro, OR 97039-9705 Dennis Carlson 41 3 2001 3255 50th Street Mandan, ND 58554 Curt Eischens 50 1 1990 2153 -- 330th St North Minneota, MN 56264-1880 Robert Elliott 52 8 1996 324 Hillcrest Alliance, NE 69301 Robert Grabarski 53 5 1999 1770 Highway 21 Arkdale, WI 54613 Jerry Hasnedl 56 1 1995 RR 1, Box 39 St. Hilaire, MN 56754 Glen Keppy 55 7 1999 21316 -- 155th Avenue Davenport, IA 52804 James Kile 54 6 1992 508 W. Bell Lane St. John, WA 99171 Randy Knecht 52 4 2001 40193 -- 112th Street Houghton, SD 57449 Leonard Larsen 66 3 1993 5128 -- 11th Ave. N. Granville, ND 58741-9595 Richard Owen 48 2 1999 PO Box 129 Geraldine, MT 59446 32 NAME AND ADDRESS AGE DISTRICT SINCE ------------------------------------ ----- ---------- ------ Duane Stenzel 56 1 1993 RR 2, Box 173 Wells, MN 56097 Michael Toelle 40 1 1992 RR 1, Box 190 Browns Valley, MN 56219 Merlin Van Walleghen 66 4 1993 24106 -- 408th Avenue Letcher, SD 57359-6021 Elroy Webster 69 1 1982 Route 2, Box 123 Nicollet, MN 56074 BRUCE ANDERSON was elected to the board in 1995. He has held positions with North Dakota Farmers Union, Farmers Union Mutual Insurance Co. and has served a four-year term in the North Dakota House of Representatives. He is a member of the North Dakota Agricultural Products Utilization Commission. Mr. Anderson and his wife raise small grains on their farm near Glenburn, North Dakota. ROBERT BASS, elected to the board in 1994, operates a 500-acre dairy and feed grain farm with his wife and brother near Reedsburg, Wisconsin. Mr. Bass currently serves as a member of the board of Co-op Country Partners in Baraboo, Wisconsin. He holds a B.S. degree from the University of Wisconsin in agricultural education and is a former vo-ag teacher. STEVEN BURNET has been a board member since 1983, has served as Chairman of the board since 1999, and has served as past Chairman of Harvest States Cooperatives from 1992 through 1997. He is a member of the Oregon Wheat Growers League and the Oregon Cattlemen's Association. Mr. Burnet is a past president of Mid-Columbia Grain Growers and past vice president of North Pacific Grain Growers. He serves as a director on the Agricultural Co-op Council of Oregon and is a former board member of the Oregon State University Alumni Association. Mr. Burnet and his wife grow dryland wheat and barley, and support a cow/calf and yearling operation with irrigated hay and pasture. DENNIS CARLSON was elected to the board in 2001. He is chairman of Farmers Union Oil Co. of Bismarck/Mandan, N.D. and has served on that board since 1989. Mr. Carlson, a third-generation cooperative member, has a diversified farm in partnership with his parents that include wheat, sunflowers and a cow/calf operation. CURT EISCHENS was elected to the board in 1990. He has been a director for Farmers Co-op Association in Canby for ten years, nine as chairman. He is director of the Minnesota Association of Cooperatives, and a member of the Minnesota Soybean Association and Minnesota Farmers Union. Mr. Eischens and his wife operate a corn and soybean farm near Canby, Minnesota. ROBERT ELLIOTT, elected to the board in 1996, is the first director for the region consisting of Nebraska, Kansas, Oklahoma, Colorado, Texas and New Mexico. He and his wife operate a 6,000-acre farm near Alliance, Nebraska. Mr. Elliott is president of the Hemingford Scholarship Foundation and serves on the Nationwide Insurance Board Counsel. He is past president of the Nebraska Wheat Growers Association and served on the boards of Western Cooperative Alliance (Westco) and New Alliance Bean & Grain Company. ROBERT GRABARSKI was elected to the Board in 1999, and has a long history of cooperative leadership. He currently serves as Board Chairman of Wisconsin River Cooperative, Adams, Wisconsin, and as First Vice Chairman of Alto Dairy Cooperative, Waupun, Wisconsin. He is active in a wide range of civic organizations, including serving on the fire department in the Adams Volunteer Fire District, as well as volunteer auctioneering for local charitable organizations. Mr. Grabarski and his wife and son operate a 1,900 acre-farm and milk 90 registered Holsteins. 33 JERRY HASNEDL was elected to the board in 1995. He is a member and past director of Northwest Grain, a Cenex Harvest States Cooperatives regionalization; a member of Farmers Union Oil Co. in Thief River Falls; Garden Valley Telephone Co-op in Erskine; Red Lake Electric Co-op in Red Lake Falls; Minnesota Wheat Growers; and Minnesota Barley Growers. He is currently serving on the interim board for Minnesota Marketplace. He and his wife raise wheat, barley, corn, soybeans, sunflowers and alfalfa on their northern Minnesota farm. GLEN KEPPY was elected to the board in 1999. Active in a wide range of agricultural and civic organizations, Mr. Keppy has served on the boards of the Iowa and National Pork Producer Associations. He is a three-time Master Soybean Grower contest winner and the recipient of the Iowa Farm Bureau's distinguished service award. A graduate of the University of Wisconsin-Platteville with a degree in technical agriculture, Mr. Keppy was drafted by the Pittsburgh Steelers and also played for the Detroit Lions and Green Bay Packers. He and his wife operate a third-generation family farm consisting of a farrow-to-finish hog operation and 1,000 acres of corn, soybeans, oats and alfalfa hay. JAMES KILE, the first graduate of Young Producer Institute to join the board, was elected in 1992. He served 18 years, 10 as chairman, on the board of his local St. John Grange Supply, and represents CHS Cooperatives on the Washington State Council of Farmer Cooperatives and is a member of Grange and Washington Association of Wheat Growers. He and his wife operate a 1,300-acre dryland wheat, barley and pea operation near St. John, Washington. RANDY KNECHT was elected to the board in 2001. Mr. Knecht has served on the board of Four Seasons Cooperative, Britton, S.D., for seven years, is chairman of the Northern Electric Cooperative board and is a member of the board of Dakota Value Capture Cooperative, Pierre, S.D. He holds a B.S. degree in agriculture from South Dakota University. With his father and a son, Mr. Knecht raises 4,000 acres of corn, beans, wheat and alfalfa. He also maintains a 450-head cow/calf operation. LEONARD LARSEN has been a board member since 1993. He is a member of the Farmers Union Oil Companies in Minot and Velva, Cenex Harvest States Sunprairie Grain, and Dakota Growers Pasta Company. Starting as a board member of the Simcoe Elevator in 1970, Leonard served through the unification with the Minot Farmers Union Elevator, where he was a board member for 11 years and chairman for six. He has served on the Hendrickson Township board, the First Lutheran Church council, and the Granville Economic Development Corporation. He is a member of the North Dakota Farmers Union and a 34-year member of the American Legion. He and his wife and a son, farm a grain, sunflower, canola and flax operation. RICHARD OWEN was elected to the board in 1999. His involvement in agriculture and civic organizations includes serving as secretary of the Central Montana Co-op, Geraldine, Mont., since 1994. Mr. Owen has served as president of the Equity Co-op Association, Geraldine, Mont., and vice chair of the Montana International Agricultural Exchange Association. He is a graduate of Montana State University, Bozeman, and has served on the university's board of directors. Mr. Owen and his wife operate a 2,200-acre dryland wheat, barley and safflower operation. DUANE STENZEL was elected to the board in 1993. He is a member of Watonwan Farm Service; Wells Farmers Elevator, where he served as board president and secretary. He raises 665 acres of soybeans, sweet corn and corn on his farm in south central Minnesota. MICHAEL TOELLE was elected to the board in 1992. He has been serving on the board of Country Partners Cooperative of Browns Valley for 12 years and as chairman for the past eight years. He also is actively involved in National FFA Organization, Ag Council of America, Minnesota Wheat Growers, Minnesota Corn Growers and Minnesota Soybean Growers associations. He currently serves as chairman of the Finance & Investment Committee for the Cenex Harvest States Foundation. He and his wife operate a grain, hog and beef farm with his brother and parents near Browns Valley. MERLIN VAN WALLEGHEN has been a board member since 1993. He is a former director of Farmers Co-op Elevator Association of Mitchell, Letcher and Alexandria, serving as board president for 11 years. Mr. Van Walleghen also served 10 years on the South Dakota Association of Cooperatives board of directors, eight as president. A former FmHA committee member, he is currently chairman of the 34 Sanborn County Development board and also a member of Heartland Consumer Power District board. He and his wife and a son, operate a grain farm producing corn and soybeans. ELROY WEBSTER was elected to the board in 1982 and served as the chairman from 1987 to 1999. His leadership record includes service as a director for the Minnesota Association of Cooperatives, Western Co-op Transport Association and Agland Cooperative. Mr. Webster is past chairman of the Agricultural Council of America and is chairman of the Board of Trustees for the Cenex Harvest States Foundation. He also works with Southwest State University as an advisor for its Cooperative Studies program. He is an active farmer with a corn and soybean operation near Nicollet, Minnesota. Elections are for three-year terms and are open to any eligible candidate. To be eligible, a candidate must meet the following qualifications: o At the time of the election, the individual must be less than the age of 68. o The individual must be a member of this cooperative or a member of a Cooperative Association Member. o The individual must reside in the region from which he or she is to be elected. o The individual must be an active farmer or rancher. "Active farmer or rancher" means an individual whose primary occupation is that of a farmer or rancher, excluding any full-time employee of the Company or of a Cooperative Association Member. o The individual must currently be serving or shall have served at least one full term as a director of a Cooperative Association Member of this cooperative. The following positions on the Board of Directors will be elected at the 2002 Annual Meeting of Members: REGION CURRENT INCUMBENT ------------------------------------------- -------------------------- Region 1 (Minnesota) Curt Eischens Jerry Hasnedl Region 2 (Montana, Wyoming) Richard Owen Region 3 (North Dakota) Bruce Anderson Region 5 (Connecticut, Indiana, Illinois, Robert Grabarski Kentucky, Michigan, Ohio, Wisconsin) Region 6 (Alaska, Arizona, California, Steve Burnet (not seeking Idaho, Oregon, Washington, re-election) Utah) Region 7 (Alabama, Arkansas, Florida, Glen Keppy Iowa, Louisiana, Missouri, Mississippi) 35 EXECUTIVE OFFICERS The table below lists the executive officers and other senior officers of the Company as of August 31, 2002. Officers are appointed annually by the Board of Directors.
NAME AGE POSITION ------------------- ----- --------------------------------------------------------------- John D. Johnson 54 President and Chief Executive Officer Patrick Kluempke 54 Executive Vice President -- Corporate Planning Tom Larson 54 Executive Vice President -- Public Affairs Mark Palmquist 45 Executive Vice President/Chief Operating Officer -- Grains and Foods John Schmitz 52 Executive Vice President and Chief Financial Officer Leon E. Westbrock 55 Executive Vice President/Chief Operating Officer -- Energy and Crop Inputs
JOHN D. JOHNSON was born in Rhame, North Dakota, and grew up in Spearfish, South Dakota. He earned a degree in business administration and a minor in economics from Black Hills State University. In 1976, he joined Harvest States Cooperatives as a feed consultant in the GTA Feeds Division, later becoming regional sales manager, Director of Sales and Marketing and then General Manager of GTA Feeds. In 1992, he was elected Group Vice President of Farm Marketing and Supply for Harvest States Cooperatives and was selected President and CEO in January 1995. Mr. Johnson became President and General Manager of Cenex Harvest State Cooperatives upon its creation June 1, 1998 and was named President and Chief Executive Officer on June 1, 2000. Mr. Johnson serves on CF Industries, Inc. and National Cooperative Refinery Association boards of directors. PATRICK KLUEMPKE, Executive Vice President of Corporate Planning, was raised on a family dairy farm in central Minnesota, and received a Bachelor of Science degree in Finance and Accounting from St. Cloud University and the University of Minnesota. Mr. Kluempke served in the United States Army in South Vietnam and South Korea, as Aide to General J. Guthrie. He began his agribusiness career in grain procurement and merchandising at General Mills and later with Louis Dreyfus Corporation in export marketing. Mr. Kluempke joined the predecessor to CHS Cooperatives when G.T.A. was being merged with North Pacific Grain Growers, in 1983, to form Harvest States Cooperatives and has held various positions in the commodity marketing division and at the corporate level. He was named to the position of Senior Vice President of Corporate Planning and Business Development in 1993 and held that position until 2000 when he was named to his current position. Mr. Kluempke serves on the board of Ventura Foods, a joint venture company between CHS Cooperatives and Mitsui & Company, Japan. TOM LARSON is Executive Vice President, Public Affairs at CHS Cooperatives. After growing up on a 480-acre crop and hog farm near Slayton, Minnesota, he earned a Bachelor's degree in Agriculture Education from South Dakota State University. After working as a vo-ag teacher, he took an agronomy sales position with Cenex, Inc. and later managed the local cooperative at Hoffman, Minnesota, for two years. Mr. Larson returned to the regional cooperative in 1978 and held positions in marketing and planning. He moved to Agronomy in 1987 and became director of Agronomy Services for Cenex/Land O'Lakes Agronomy Company in 1988. He was later named Vice President of Agronomy Services until 1996 when he became Vice President of Cenex Supply and Marketing which included overseeing the operation of more than two dozen Cenex-owned agricultural supply outlets. Mr. Larson was named to his current position in January 1999. He oversees the public affairs area of the Company, which includes communications, corporate giving, meetings and travel and governmental affairs, including the Washington, D.C. office. He is active in the FFA organization and is a recipient of its Honorary American Degree. MARK PALMQUIST is the Executive Vice President and Chief Operating Officer of Grains and Foods. He is responsible for all related areas of grains including country operations, terminal operations, exports, logistics, transportation and grain marketing joint ventures. He is also responsible for the operations of wheat milling, oilseed processing and refining, and food manufacturing and packaging. Mr. Palmquist has worked for CHS Cooperatives for 21 years. Starting as a grain buyer and moving into merchandising, he has traded many different commodities including corn, soybeans and spring wheat. In 36 1990, he assumed the role of Vice President and director of Grain Marketing and then in 1993, was promoted to Senior Vice President, which he held until 2000 when he was named to his current position. Mr. Palmquist attended Gustavus Adolphus College in St. Peter, Minnesota, graduating in 1979. He also attended the Master of Business Administration program at the University of Minnesota. Mr. Palmquist serves on Ventura Foods board of directors. JOHN SCHMITZ is the Executive Vice President and Chief Financial Officer of the Company. Mr. Schmitz joined Harvest States Cooperatives in 1974 as Corporate Accountant and has held a number of accounting and finance positions within the Company, including divisional controller positions in Country Services, Farm Marketing & Supply and Grain Marketing. In 1986, he was named Vice President and Controller of Harvest States Cooperatives, and had served in that position up to the time of the merger with Cenex when he became Vice President, Finance, of CHS Cooperatives. In May 1999, Mr. Schmitz became Senior Vice President and Chief Financial Officer. Mr. Schmitz earned a Bachelor of Science Degree in Accounting from St. Cloud State University, and is a member of the American Institute of Certified Public Accountants, the Minnesota Society of CPA's and the National Society of Accountants for Cooperatives. Mr. Schmitz serves on National Cooperative Refinery Association and Ventura Foods boards of directors. LEON E. WESTBROCK is the Executive Vice President and Chief Operating Officer of Energy and Crop Inputs for the Company. He joined the cooperative system in 1976 and managed three local cooperatives before joining the regional system. At the regional level, Mr. Westbrock served in the Merchandising Department at Cenex, Inc. and then later as Manager of the Lubricants Department and as Director of Retailing. Since January 1, 1987, he served as Vice President and Executive Vice President in the Energy Division of the Company. On March 1, 2000 Mr. Westbrock was appointed to his current position. He serves as chairman for both National Cooperative Refinery Association and Universal Cooperatives, Inc. boards of directors and also serves as a member of the Agriliance, LLC board of directors. Mr. Westbrock received a Bachelor's Degree from St. Cloud State University and served a tour in the U.S. Army. 37 ITEM 11. EXECUTIVE COMPENSATION SUMMARY COMPENSATION. The following table sets forth the cash and noncash compensation earned by the Chief Executive Officer and each of the executive officers of the Company whose total salary and bonus or similar incentive payment earned during the year ended August 31, 2002, exceeded $100,000 (the "Named Executive Officers"): SUMMARY COMPENSATION TABLE
LONG-TERM ANNUAL COMPENSATION COMPENSATION ------------------------------------------------------------------------------- ------------- NAME AND OTHER ANNUAL ALL OTHER LTIP PRINCIPAL POSITION YEAR ENDED SALARY(1) BONUS(1) COMPENSATION(2) COMPENSATION(3) PAYOUTS(1) -------------------------------- ------------ ----------- ---------- ----------------- ----------------- ------------- John. D. Johnson 8/31/02 $820,000 $811,750 $30,376 $10,216 President and Chief Executive 8/31/01 787,500 747,338 8,600 9,606 Officer 8/31/00 600,000 540,000 14,672 12,720 $719,280 Patrick Kluempke 8/31/02 223,000 166,875 15,120 10,873 Executive Vice President -- 8/31/01 200,000 162,675 3,780 6,010 Corporate Planning 8/31/00 176,500 68,664 8,194 7,068 92,995 Tom Larson 8/31/02 229,100 172,200 18,878 10,214 Executive Vice President -- 8/31/01 200,000 167,850 16,130 8,189 Public Affairs 8/31/00 182,768 71,665 6,240 7,160 97,060 Mark Palmquist 8/31/02 453,400 342,000 15,120 11,081 Executive Vice President and 8/31/01 375,000 232,680 14,111 5,863 Chief Operating Officer -- 8/31/00 262,932 235,168 2,620 7,068 184,273 Grains and Foods John Schmitz 8/31/02 317,300 244,500 21,856 12,255 Executive Vice President and 8/31/01 275,000 232,500 2,520 7,080 Chief Financial Officer 8/31/00 210,583 100,377 82 8,566 135,947 Leon E. Westbrock 8/31/02 453,400 342,000 15,120 12,057 Executive Vice President and 8/31/01 375,000 332,400 7,320 5,116 Chief Operating Officer -- 8/31/00 323,750 86,745 4,808 184,273 Energy and Crop Inputs
------------------ (1) Amounts shown include amounts deferred at the employee's election under the Company's Deferred Compensation Program and amounts waived in exchange for options under the Company's Share Option Plan. (2) Amounts shown include personal use of a Company vehicle. (3) Other compensation includes the Company's matching contributions under the Company's 401(k) Plan and the portion of group term life insurance premiums paid by the Company. On September 1, 2000, the Company entered into an employment agreement with John D. Johnson, the President and CEO. The employment agreement provides for a rolling three-year period of employment commencing on September 1, 2000 at an initial base salary of at least $787,500, subject to annual review. Either party, subject to the rights and obligations set forth in the employment agreement, may terminate Mr. Johnson's employment at any time. The Company is obligated to pay Mr. Johnson a severance allowance of 2.99 times his base salary and target bonus in the event Mr. Johnson's employment is terminated for any reason other than for cause (as such term is defined in the employment agreement), death, disability or voluntary termination. The employment agreement includes a provision to pay Mr. Johnson a severance allowance of 2.99 times his base salary and target bonus in the event of the consolidation of the Company's business with the business of any other entity, if Johnson is not offered the position of Chief Executive Officer of the combined entity. The contract provides for a gross-up for any possible excise tax. Mr. Johnson has also agreed to a non-compete clause of two years, in the event of his termination. REPORT ON EXECUTIVE COMPENSATION The Corporate Responsibility Committee of the Board of Directors, subject to the approval of the Board of Directors, determines the compensation of Cenex Harvest States Cooperatives chief executive officer and oversees the administration of the executive compensation programs. 38 EXECUTIVE COMPENSATION POLICIES AND PROGRAMS Cenex Harvest States Cooperatives executive compensation programs are designed to attract and retain highly qualified executives and to motivate them to optimize member owner returns by achieving aggressive goals. The compensation program links executive compensation directly to the Company's performance. A significant portion of each executive's compensation is dependent upon value-added operations and meeting financial goals and other individual performance objectives. Each year, the Committee reviews the executive compensation policies with respect to the correlation between executive compensation and the creation of member owner value, as well as the competitiveness of the programs. The Committee determines what, if any, changes are appropriate to executive compensation programs of Cenex Harvest States Cooperatives. The Committee recommends to the total Board of Directors, salary actions relative to the chief executive officer and determines the amount of annual variable pay and the amount of long-term awards. The Company intends to the extent possible, to preserve the deductibility under the Internal Revenue Code of compensation paid to its executive officers while maintaining compensation programs to attract and retain highly qualified executives in a competitive environment. Accordingly, compensation paid under Cenex Harvest States Cooperatives share option plan and incentive compensation plan is generally deductible. COMPONENTS OF COMPENSATION There are three basic components to the Cenex Harvest States Cooperatives executive compensation plan: base pay; annual variable pay; and long-term variable pay (grants in the share option plan). Each component is designed to be competitive within the executive compensation market. In determining competitive compensation levels, the Company analyzes information from several independent compensation surveys, which include information regarding a comparable all-industrial market and other companies that compete for executive talent. BASE PAY: Base pay is designed to be competitive at the 50th percentile of other large companies for equivalent positions. The executive's actual salary relative to this competitive benchmark varies based on individual performance and the individual's skills, experience and background. ANNUAL VARIABLE PAY: Award levels, like the base pay levels, are set with reference to competitive conditions and are intended to motivate the executives by providing substantial incentive payments for the achievement of aggressive goals. The actual amounts paid for 2002 were determined based on two factors: first, profitability and financial performance of the Company and the executive's business unit; and second, the individual executive's performance against other specific management objectives such as revenue growth, value added performance, talent development. Financial objectives are given greater weight than individual performance objectives in determining individual awards. The types and relative importance of specific financial and other business objectives varied among executives depending upon their positions and the particular business unit for which they were responsible. LONG-TERM VARIABLE PAY: The main purpose of the long-term variable pay program is to encourage the Cenex Harvest States Cooperatives' executives to increase the value of doing business with the Company by increasing and improving value added business opportunities and therefore the value of member owners doing business with Cenex Harvest States Cooperatives. The long-term variable pay component of the compensation program (through extended vesting) is also designed to create an incentive for the individual to remain with the Company. The long-term variable pay program consists of grants of shares in the restricted investment corporations sponsored by Cenex Harvest States Cooperatives. These options vest over a multi-year period. The Company periodically grants new awards to provide continuing incentives for future performance. Like the annual variable pay, award levels are set with regard to competitive considerations and each individual's actual award is based on financial performance of the Company, collectively. No grant was awarded in 2002 due to the fact that no award period had matured during the fiscal year. COMPENSATION OF THE CHIEF EXECUTIVE OFFICER In determining the compensation of the chief executive officer, the Committee considers three factors: the absolute and relative performance of the business particularly as it relates to variable pay; 39 the market for such positions; and Cenex Harvest States Cooperatives compensation strategy in determining the mix of base, annual, and long-term variable pay. In general, the Company's strategy is to distribute pay for the chief executive officer among the three basic components so that it effectively reflects the competitive market with major consideration for achievement of individual performance objectives. Mr. Johnson's actual base salary for fiscal year 2002 was $820,000. Based on Cenex Harvest States Cooperatives financial performance in terms of profitability and other individual goals related to achieving communications objectives, business partner accountability and other strategic objectives, Mr. Johnson received an annual variable pay award of $811,750 for fiscal year 2002. This incentive payment was consistent with his achievement of performance standards set by the Board of Directors. Mr. Johnson received no long-term variable pay award for fiscal year 2002 as no award period had matured during that time. THE FOLLOWING SUMMARIZES CERTAIN BENEFITS IN EFFECT AS OF AUGUST 31, 2002 TO THE NAMED EXECUTIVE OFFICERS. MANAGEMENT COMPENSATION INCENTIVE PROGRAM Each Named Executive Officer is eligible to participate in the Management Compensation Incentive Program (the "Incentive Program") for the year ending August 31, 2002. The Incentive Program is based on Company, group or division performance and individual performance. These amounts will be paid after August 31, 2002. The target incentive is 50% of base compensation except for the President and Chief Executive Officer, where target incentive is 67% of base compensation. LONG-TERM INCENTIVE PLAN Each Named Executive Officer is eligible to participate in the Long-Term Incentive Plan. The plan consists of a three-year performance period. Award opportunities are expressed as a percentage of a participating employee's position mid-point. Company performance must meet a minimum level of pre-tax earnings per unit of sales and net income levels before any grants are made from this plan. Awards from the plan are grants to the Company's Share Option Plan at the end of each plan period. LONG-TERM INCENTIVE PLANS -- AWARDS IN LAST FISCAL YEAR
MATURATION NAME AND PRINCIPAL POSITION AWARD OF AWARD THRESHOLD TARGET MAXIMUM -------------------------------------------- ------- ----------- ----------- ----------- ------------ John. D. Johnson -0- 2001-2003 $82,000 $549,400 $ 820,000 President and Chief Executive Officer Patrick Kluempke -0- 2001-2003 16,875 111,806 166,875 Executive Vice President -- Corporate Planning Tom Larson -0- 2001-2003 17,220 115,374 172,200 Executive Vice President -- Public Affairs Mark Palmquist -0- 2001-2003 34,200 229,140 342,000 Executive Vice President and Chief Operating Officer -- Grain and Foods John Schmitz -0- 2001-2003 24,450 163,815 244,500 Executive Vice President and Chief Financial Officer Leon E. Westbrock -0- 2001-2003 34,200 229,140 342,000 Executive Vice President and Chief Operating Officer -- Energy and Crop Inputs
RETIREMENT PLAN Each of the Named Executive Officers is entitled to receive benefits under the Company's Cash Balance Retirement Plan (the "Retirement Plan"). An employee's benefit under the Retirement Plan 40 depends on credits to the employee's account, which are based on the employee's total salary each year the employee works for the Company, the length of service with the Company and the rate of interest credited to the employee's account balance each year. Credits are made to the employee's account from Pay Credits, Special Career Credits and Investment Credits. The amount of Pay Credits added to an employee's account each year is a percentage of the employee's gross salary, including overtime pay, commissions, severance pay, bonuses, any compensation reduction pursuant to the 401(k) Plan and any pretax contribution to any of the Company's welfare benefit plans, paid vacations, paid leaves of absence and pay received if away from work due to a sickness or injury. The Pay Credits percentage received is determined on a yearly basis, based on the years of Benefit Service completed as of January 1 of each year. An employee receives one year of Benefit Service for every calendar year of employment in which the employee completed at least 1,000 hours of service. Effective January 1, 2002, Pay Credits are earned according to the following schedule:
PAY BELOW SOCIAL SECURITY PAY ABOVE SOCIAL SECURITY YEARS OF BENEFIT SERVICE TAXABLE WAGE BASE TAXABLE WAGE BASE ------------------------------ --------------------------- -------------------------- 1 to 3 years .............. 3% 6% 4 to 7 years .............. 4% 8% 8 to 11 years ............. 5% 10% 12 to 15 years ............ 6% 12% 16 years and more ......... 7% 14%
The Company credits an employee's account at the end of the year with an Investment Credit based on the balance at the beginning of the year. The Investment Credit is based on the average return for one-year U.S. Treasury Bills for the preceding 12-month period. The maximum Investment Credit will not exceed 12% for any year. As of December 31, 2001, the dollar value of the account and years of service for each of the Named Executive Officers was: DOLLAR VALUE YEARS OF SERVICE -------------- ----------------- John D. Johnson ............ $884,775 26 Patrick Kluempke ........... 433,378 19 Tom Larson ................. 361,813 25 Mark Palmquist ............. 474,183 22 John Schmitz ............... 414,876 27 Leon E. Westbrock .......... 942,075 21 SHARE OPTION PLAN In October 1997, the Company adopted a Share Option Plan. Participants in the plan, which include all Named Executive Officers, are select management of the Company who have been designated as eligible by the President of the Company to participate in such plan. The Share Option Plan allows participants to waive bonuses and up to 30 percent of salary in exchange for options to purchase at a discount, shares of selected mutual funds. The Company has filed a Form S-8, dated December 12, 1997 on this program. This plan allows officers to buy investments at a specific price. Some options have vesting schedules. 41 The following is a share option grants table showing each Named Executive Officer option activity for the fiscal year ended August 31, 2002. The dollars in the "Realizable Value" columns of the table are computed as of the expiration date. All grants are salary exchanges, and not additional income to the employee.
% OF $ NUMBER OF TOTAL EXERCISE EXPIRATION REALIZABLE REALIZABLE REALIZABLE NAME SECURITIES OPTIONS PRICE DATE VALUE 5% VALUE 10% VALUE 0% ------------------- --------------- ----------- ---------- ------------ ------------ ------------ ----------- John. D. Johnson 5,555.5556 12.20% $ 9.00 9/30/2021 $ 139,298 $ 370,013 $ 37,500 John. D. Johnson 107,328.2050 28.77% 9.75 12/31/2021 2,776,543 7,039,992 784,837 John. D. Johnson 7,723.9960 14.31% 9.70 3/31/2022 198,997 504,562 56,192 John. D. Johnson 8,522.720 19.59% 8.80 6/30/2022 198,997 504,562 56,250 Patrick Kluempke 22,430.1960 6.01% 9.67 12/31/2021 575,501 1,459,195 162,675 Mark Palmquist 860.2151 1.89% 9.30 9/30/2021 21,227 51,373 6,000 Mark Palmquist 32,308.6290 8.66% 9.85 12/31/2021 844,386 2,140,960 238,680 Mark Palmquist 816.3270 1.51% 9.79 3/31/2022 21,227 51,373 5,994 Mark Palmquist 876.2320 2.01% 9.13 6/30/2022 21,227 51,373 6,000 Leon E. Westbrock 45,832.4720 12.28% 9.67 12/31/2021 1,175,941 2,981,628 332,400
The following is a share option grants table showing each Named Executive Officer, along with the number and value of shares exercised for the fiscal year ended August 31, 2002, and the number of underlying unexercised options and the value of unexercised in-the-money options, as of the most recent statement period ended June 30, 2002.
NUMBER OF NUMBER OF VALUE OF VALUE OF SECURITIES SECURITIES UNEXERCISED UNEXERCISED VALUE OF UNDERLYING UNDERLYING IN-THE-MONEY IN-THE-MONEY NUMBER OF SHARES OPTIONS OPTIONS OPTIONS OPTIONS NAME SHARES EXERCISED EXERCISED EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE ------------------- ------------------ ----------- ---------------- --------------- -------------- -------------- John. D. Johnson 312,229.323 8,522.727 $1,969,996 $56,250 Patrick Kluempke 103,183.870 640,424 Thomas Larson 56,364.534 357,119 Mark Palmquist 31,036.000 $221,287 33,110.324 876.232 220,737 6,000 John Schmitz 34,297.224 234,644 Leon E. Westbrock 479,558.960 3,091,117
401(k) PLAN Each Named Executive Officer is eligible to participate in the Cenex Harvest States Savings Plan (the 401(k) Plan). All benefit-eligible employees of the Company are eligible to participate in the 401(k) Plan. Effective January 1, 2002, participants may contribute between 1% and 50% (not to exceed 6% in the case of "highly compensated" employees) of their pay on a pre-tax basis. Each of the Named Executive Officers is a "highly compensated" employee. The Company matches 50% of the first 6% of pay contributed each year. The Company's Board of Directors may elect to reduce or eliminate matching contributions for any year or any portion thereof. Participants are 100% vested in their own contributions and are fully vested after three years of service in any Company matching contribution made on the participant's behalf. DEFERRED COMPENSATION SUPPLEMENTAL RETIREMENT PLAN Each of the Named Executive Officers may participate in the Company's Deferred Compensation Supplemental Retirement Plan (the Supplemental Plan). Participants in the Supplemental Plan are select management or highly compensated employees of the Company who have been designated as eligible by the President of the Company to participate in such plan. Compensation waived under the Share Option Plan is not eligible for Pay Credits under the Cash Balance Retirement Plan or matching contributions under the 401(k) Plan. The Supplemental Plan is intended to replace the benefits lost under those plans due to Section 415 of the Internal Revenue Code of 1986, as amended (the Code) which cannot be considered for purposes of benefits due to Section 401(a)(17) of the Code under the qualified plans that the Company offers. The Supplemental Plan is not funded or qualified for special tax treatment under the Code. 42 As of December 31, 2001, the dollar value of the account of each of the Named Executive Officers was approximately: John D. Johnson ................. $1,601,593 Patrick Kluempke ................ 65,334 Tom Larson ...................... 246,945 Mark Palmquist .................. 158,241 John Schmitz .................... 128,210 Leon E. Westbrock ............... 790,757 DIRECTORS' COMPENSATION The Board of Directors met monthly during the year ended August 31, 2002. Through August 31, 2002, the Company provided each director with compensation of $42,000, paid in twelve monthly payments, with the Chairman of the Board receiving an additional annual compensation of $12,000, paid in twelve monthly payments. Each director receives a per diem of $300 plus actual expenses and travel allowance for each day spent on Company meetings (other than regular Board meetings and the Annual Meeting), life insurance and health and dental insurance. Each director has a retirement benefit of $125 per month per year of service, with a maximum benefit of $1,875 per month, for life with a guarantee of 120 months (paid to beneficiary in the event of death). This benefit commences at age 60 or retirement, whichever is later. This retirement benefit may be converted to a lump sum. The retired directors may also continue health benefits until eligible for Medicare and thereafter pay at their own expense for a Medicare supplemental policy. The retirement benefit was raised to $175 per month effective for retirements after December 31, 2002. COMMITTEES OF THE BOARD OF DIRECTORS The Board of Directors appoints ad hoc committees from time to time to review certain matters and make reports and recommendations to the full Board of Directors for action. The entire Board of Directors determines the salaries and incentive compensation for the President and Chief Executive Officer using industry and compensation studies. The Board of Directors has a standing committee to review the results and scope of the annual audit and other services provided by the Company's independent auditors, and another standing committee to review equity redemption policy and its application to situations believed by the equity holder or patron's equity department to be unusual. COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION As noted above, the Company's Board of Directors did not have a Compensation Committee. The entire Board of Directors determined the compensation of the President and Chief Executive Officer and the terms of the employment agreement with the President and Chief Executive Officer. The President and Chief Executive Officer determined the compensation for all other executive officers. 43 ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT Beneficial ownership of equity securities as of August 31, 2002, is shown below:
AMOUNT AND NATURE OF BENEFICIAL TITLE OF CLASS NAME OF BENEFICIAL OWNER(1) OWNERSHIP % OF CLASS -------------- ------------------------------------------------------- -------------- ---------- 8% Preferred Stock Directors: Steven Burnet ....................................... -- Bruce Anderson ...................................... -- Robert Bass ......................................... 3,000 shares * Dennis Carlson ...................................... 1,500 shares * Curt Eischens ....................................... 3,000 shares * Robert Elliott ...................................... 6,000 shares * Robert Grabarski .................................... 12,000 shares * Jerry Hasnedl ....................................... 1,000 shares * Glen Keppy .......................................... 5,000 shares * Jim Kile ............................................ 3,000 shares * Randy Knecht ........................................ 1,000 shares * Leonard Larsen ...................................... 2,000 shares * Richard Owen ........................................ 6,000 shares * Duane Stenzel ....................................... 10,000 shares * Michael Toelle ...................................... 5,500 shares * Merlin Van Walleghen ................................ 30,000 shares * Elroy Webster ....................................... 10,000 shares * Executive Officers: John D. Johnson ..................................... 60,000 shares * Patrick Kluempke .................................... 6,000 shares * Tom Larson .......................................... 1,000 shares * Mark Palmquist ...................................... 10,000 shares * John Schmitz ........................................ 25,000 shares * Leon E. Westbrock ................................... 10,000 shares * -------------- --- Directors and executive officers as a group ......... 211,000 shares 2.3%
------------------ (1) Includes shares held by spouse and children. * Less than 1%. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS Because directors must be active patrons of the Company or an Affiliated Association, transactions between the Company and directors are customary and expected. Transactions include the sale of commodities to the Company and the purchase of products and services from the Company, as well as patronage refunds and equity redemptions received from the Company. During the period indicated, the value of those transactions between a particular director (and members of such directors' immediate family, which includes such director's spouse; parents; children; siblings; mothers and fathers-in-law; sons and daughters-in-law; and brothers and sisters-in-law) and the Company that exceeded $60,000 are shown below. YEAR ENDED NAME AUGUST 31, 2002 ---- --------------- Bruce Anderson ......................................... $ 66,777 Jerry Hasnedl .......................................... 442,288 Leonard Larsen ......................................... 140,893 Merlin Van Walleghen ................................... 106,643 44 PART IV. ITEM 14. CONTROLS AND PROCEDURES The Company's Chief Executive Officer and Chief Financial Officer have concluded, based on their evaluation within 90 days of the filing date of this report, that the Company's disclosure controls and procedures are adequately designed to ensure that information required to be disclosed by the Company in the reports that it files or submits under the Securities and Exchange Act of 1934, as amended, is recorded, processed, summarized and reported, within the time periods specified in applicable rules and forms. There have not been any significant changes in the Company's internal controls or in other factors that could significantly affect those controls, subsequent to the date of such evaluation, including any corrective actions taken with regard to significant deficiencies and material weaknesses. ITEM 15. EXHIBITS, FINANCIAL STATEMENTS AND REPORTS FILED ON FORM 8-K (a)(1) FINANCIAL STATEMENTS The following financial statements and the Reports of Independent Accountants are filed as part of this Form 10-K.
PAGE NO. --------- CENEX HARVEST STATES COOPERATIVES Consolidated Balance Sheets as of August 31, 2002 and 2001 .................................... F-1 Consolidated Statements of Operations for the years ended August 31, 2002, 2001 and 2000 ...... F-2 Consolidated Statements of Equities and Comprehensive Income for the years ended August 31, 2002, 2001 and 2000 .............................................................. F-4 Consolidated Statements of Cash Flows for the years ended August 31, 2002, 2001 and 2000 ...... F-6 Notes to Consolidated Financial Statements .................................................... F-7 Report of Independent Accountants ............................................................. F-26 VENTURA FOODS, LLC, A NON-CONSOLIDATED 50% OWNED EQUITY INVESTMENT Independent Auditors' Report .................................................................. F-27 Consolidated Balance Sheets as of March 31, 2002 and 2001 ..................................... F-28 Consolidated Statements of Income for the years ended March 31, 2002, December 31, 2000 and 1999 and the three months ended March 31, 2001 .......................................... F-29 Consolidated Statements of Members' Capital for the years ended March 31, 2002, December 31, 2000 and 1999 and the three months ended March 31, 2001 ........................ F-30 Consolidated Statements of Cash Flows for the years ended March 31, 2002, December 31, 2000 and 1999 and the three months ended March 31, 2001 ..................................... F-31 Notes to Consolidated Financial Statements for the years ended March 31, 2002, December 31, 2000 and 1999 and the three months ended March 31, 2001 ..................................... F-32
------------------ *Audited financial statements for Ventura Foods, LLC, as of and for the year ended March 31, 2003 will be filed by an amendment to this Form 10-K. (a)(2) FINANCIAL STATEMENT SCHEDULES Financial statement schedules are omitted because they are not applicable or the required information is shown in the financial statements or notes thereto. (a)(3) EXHIBITS 3.1 Amended and Restated Articles of Incorporation of the Company. (1) 3.2 Amended and Restated By-Laws of the Company. (15) 4.1 Cenex Harvest States Cooperatives Certificate of Designations for the 8% Preferred Stock. (12) 10.1 Lease between the Port of Kalama and North Pacific Grain Growers, Inc., dated November 22, 1960. (2) 10.2 Limited Liability Company Agreement for the Wilsey-Holsum Foods, LLC dated July 24, 1996. (2)
45 10.3 Long Term Supply Agreement between Wilsey-Holsum Foods, LLC and Harvest States Cooperatives dated August 30, 1996. (*) (2) 10.4 TEMCO, LLC Limited Liability Company Agreement between Cargill, Incorporated and Cenex Harvest States Cooperatives dated as of August 26, 2002. (15) 10.5 Cenex Harvest States Cooperatives Supplemental Savings Plan. (9) 10.6 Cenex Harvest States Cooperatives Supplemental Executive Retirement Plan. (9) 10.7 Cenex Harvest States Cooperatives Senior Management Compensation Plan. (9) 10.8 Cenex Harvest States Cooperatives Executive Long-Term Variable Compensation Plan. (9) 10.9 Cenex Harvest States Cooperatives Share Option Plan. (9) 10.9A Amendment to Cenex Harvest States Share Option Plan, dated June 28, 2001. (12) 10.10 $225,000,000 Note Agreement (Private Placement Agreement) dated as of June 19, 1998 among Cenex Harvest States Cooperatives and each of the Purchases of the Notes. (3) 10.11 $400 Million 364-day and $200 Million 5-Year Revolving Loan Credit Agreement dated as of June 1, 1998 among Cenex Harvest States Cooperatives, CoBank, ACB, St. Paul Bank for Cooperatives, et al., including Exhibit 2.4 (form of 364-Day Facility Note) and Exhibit 3.4 (form of 5-Year Note). (3) 10.11A First Amendment to Credit Agreement (Revolving Loan), effective as of May 31, 1999 among Cenex Harvest States Cooperatives, CoBank, ACB, NationsBank, N.A. and St. Paul Bank for Cooperatives. (5) 10.11B Second Amendment to Credit Agreement (Revolving Loan) dated May 23, 2000 by and among Cenex Harvest States Cooperatives, CoBank, ACB, Bank of America, SunTrust Bank and the Syndication Parties. (8) 10.11C Third Amendment to Credit Agreement (Revolving Loan) dated May 23, 2001 among Cenex Harvest States Cooperatives, CoBank, ACB, Cooperatieve Centrale Raiffeisen- Boerenleenbank, B.A., SunTrust Bank, BNP Paribas and the Syndication Parties. (11) 10.11D Fourth Amendment to Credit Agreement (Revolving Loan) dated May 22, 2002 among Cenex Harvest States Cooperatives, CoBank, ACB, Cooperatieve Centrale Raiffeisen- Boerenleenbank, B.A., SunTrust Bank, Deere Credit, Inc., Credit Lyonnais Chicago Branch and the Syndication Parties. (14) 10.12 $200 Million Term Loan Credit Agreement dated as of June 1, 1998 among Cenex Harvest States Cooperatives, CoBank, ACB, and St. Paul Bank for Cooperatives, including Exhibit 2.4 (form of $200 Million Promissory Note). (3) 10.12A First Amendment to Credit Agreement (Term Loan), effective as of May 31, 1999 among Cenex Harvest States Cooperatives, CoBank, ACB, and St. Paul Bank for Cooperatives. (5) 10.12B Second Amendment to Credit Agreement (Term Loan) dated May 23, 2000 by and among Cenex Harvest States Cooperatives, CoBank, ACB, St. Paul Bank for Cooperatives and the Syndication Parties. (8) 10.12C Third Amendment to Credit Agreement (Term Loan) dated May 23, 2001 among Cenex Harvest States Cooperatives, CoBank, ACB, and the Syndication Parties. (11) 10.12D Fourth Amendment to Credit Agreement (Term Loan) dated May 22, 2002 among Cenex Harvest States Cooperatives, CoBank, ACB and the Syndication Parties. (14) 10.13 Limited Liability Agreement of United Harvest, LLC dated November 9, 1998 between United Grain Corporation and Cenex Harvest States Cooperatives. (4)
46 10.14 $50 Million 364-Day Revolving Loan Credit Agreement dated as of December 21, 1999 among National Cooperative Refinery Association, CoBank, ACB, Mercantile Bank and Bank of America, N.A. (6) 10.14A First Amendment to Credit Agreement (364-Day Revolving Loan) dated December 19, 2000 by and among National Cooperative Refinery Association, CoBank, ACB and Firstar Bank, N.A. (13) 10.15 Joint Venture Agreement for Agriliance LLC, dated as of January 1, 2000 among Farmland Industries, Inc., Cenex Harvest States Cooperatives, United Country Brands, LLC and Land O' Lakes, Inc. (7) 10.16 Employment Agreement dated September 1, 2000 by and between John D. Johnson and Cenex Harvest States Cooperatives. (9) 10.17 Note purchase and Private Shelf Agreement dated as of January 10, 2001 between Cenex Harvest States Cooperatives and The Prudential Insurance Company of America. (10) 10.17A Amendment No. 1 to Note Purchase and Private Shelf Agreement, dated as of March 2, 2001. (10) 10.18 Note Purchase Agreement and Series D & E Senior Notes dated October 18, 2002. (15) 21.1 Subsidiaries of the Registrant. (15) 23.1 Consent of Independent Accountants. (15) 23.2 Independent Auditors' Consent. (15) 24.1 Power of Attorney. (15) 99.1 Cautionary Statement. (15) 99.2 Statement under oath of John D. Johnson, principal executive officer regarding the facts and circumstances relating to Exchange Act filings required by Order 4-460. (15) 99.3 Statement under oath of John Schmitz, principal financial officer regarding the facts and circumstances relating to Exchange Act filings required by Order 4-460. (15) 99.4 Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. (15) 99.5 Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. (15)
------------------ (*) Pursuant to Rule 406 of the Securities Act of 1933, as amended, confidential portions of Exhibit 10.3 have been deleted and filed separately with the Securities and Exchange Commission pursuant to a request for confidential treatment. (1) Incorporated by reference to the Company's Form 8-K filed June 10, 1998. (2) Incorporated by reference to the Company's Registration Statement on Form S-1 (File No. 333-17865), effective February 14, 1997. (3) Incorporated by reference to the Company's Form 10-Q Transition Report for the period June 1, 1998 to August 31, 1998, filed October 14, 1998. (4) Incorporated by reference to the Company's Form 10-Q for the quarterly period ended November 30, 1998, filed January 13, 1999. (5) Incorporated by reference to the Company's Form 10-Q for the quarterly period ended May 31, 1999, filed July 13, 1999. (6) Incorporated by reference to the Company's Form 10-Q for the quarterly period ended November 30, 1999, filed January 12, 2000. (7) Incorporated by reference to the Company's Form 10-Q for the quarterly period ended February 29, 2000 filed April 11, 2000. 47 (8) Incorporated by reference to the Company's Form 10-Q for the quarterly period ended May 31, 2000, filed July 10, 2000. (9) Incorporated by reference to the Company's Form 10-K for the year ended August 31, 2000, filed November 22, 2000. (10) Incorporated by reference to the Company's Form 10-Q for the quarterly period ended February 28, 2001, filed April 10, 2001. (11) Incorporated by reference to the Company's Form 10-Q for the quarterly period ended May 31, 2001, filed July 3, 2001. (12) Incorporated by reference to the Company's Registration Statement on Form S-2 (File No. 333-65364), effective October 31, 2001. (13) Incorporated by reference to the Company's Form 10-K for the year ended August 31, 2001, filed November 19, 2001. (14) Incorporated by reference to the Company's Form 10-Q for the quarterly period ended May 31, 2002, filed July 3, 2002. (15) Filed herewith. (b) REPORTS ON FORM 8-K No reports on Form 8-K have been filed by the Registrant during the fourth quarter of the year ended August 31, 2002. (c) EXHIBITS The exhibits shown in Item 15(a)(3) above are being filed herewith. (d) SCHEDULES None. SUPPLEMENTAL INFORMATION As a cooperative, the Company does not utilize proxy statements. 48 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, as amended, the Registrant has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized, on November 25, 2002. CENEX HARVEST STATES COOPERATIVES By: /s/ JOHN D. JOHNSON ----------------------------- John D. Johnson PRESIDENT AND CHIEF EXECUTIVE OFFICER Pursuant to the requirements of the Securities Exchange Act of 1934, this Report has been signed below by the following persons on behalf of the Registrant and in the capacities indicated on November 25, 2002:
SIGNATURE TITLE --------------------------------------------------------------- ----------------------------------------------------- /s/ JOHN D. JOHNSON President and Chief Executive Officer ------------------------------------- (principal executive officer) John D. Johnson /s/ JOHN SCHMITZ Executive Vice President and Chief Financial Officer ------------------------------------- (principal financial officer) John Schmitz /s/ JODELL HELLER Vice President and Controller ------------------------------------- (principal accounting officer) Jodell Heller Steven Burnet* Chairman of the Board of Directors Bruce Anderson* Director Robert Bass* Director Dennis Carlson* Director Curt Eischens* Director Robert Elliott* Director Robert Grabarski* Director Jerry Hasnedl* Director Glen Keppy* Director James Kile* Director Randy Knecht* Director Leonard Larsen* Director Richard Owen* Director Duane Stenzel* Director Michael Toelle* Director Merlin Van Walleghen* Director Elroy Webster* Director * By: /s/ JOHN D. JOHNSON ------------------- John D. Johnson ATTORNEY-IN-FACT
49 SECTION 302 CERTIFICATION I, John D. Johnson, certify that: 1. I have reviewed this annual report on Form 10-K of Cenex Harvest States Cooperatives; 2. Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report. 3. Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual report; 4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and have: a. designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries is made known to us by others within those entities, particularly during the period in which this annual report is being prepared; b. evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this annual report (the "Evaluation Date"); and c. presented in this annual report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; 5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent functions): a. all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and b. any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and 6. The registrant's other certifying officers and I have indicated in this annual report whether there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. Date: November 25, 2002 /s/ John D. Johnson ------------------- John D. Johnson President and Chief Executive Officer 50 SECTION 302 CERTIFICATION I, John Schmitz, certify that: 1. I have reviewed this annual report on Form 10-K of Cenex Harvest States Cooperatives; 2. Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report. 3. Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual report; 4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and have: a. designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries is made known to us by others within those entities, particularly during the period in which this annual report is being prepared; b. evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this annual report (the "Evaluation Date"); and c. presented in this annual report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; 5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent functions): a. all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and b. any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and 6. The registrant's other certifying officers and I have indicated in this annual report whether there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. Date: November 25, 2002 /s/ John Schmitz ---------------- John Schmitz Executive Vice President and Chief Financial Officer 51 CENEX HARVEST STATES COOPERATIVES AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS AUGUST 31, 2002 AND 2001
2002 2001 ------------- ------------- (DOLLARS IN THOUSANDS) ASSETS CURRENT ASSETS: Cash and cash equivalents .................................. $ 108,192 $ 113,458 Receivables ................................................ 741,578 686,140 Inventories ................................................ 759,663 510,443 Other current assets ....................................... 140,944 60,995 ---------- ---------- Total current assets ..................................... 1,750,377 1,371,036 Investments ................................................. 496,607 467,953 Property, plant and equipment ............................... 1,057,421 1,023,872 Other assets ................................................ 177,322 194,458 ---------- ---------- TOTAL ASSETS ............................................. $3,481,727 $3,057,319 ========== ========== LIABILITIES AND EQUITIES CURRENT LIABILITIES: Notes payable .............................................. $ 332,514 $ 97,195 Current portion of long-term debt .......................... 89,032 17,754 Customer credit balances ................................... 26,461 38,486 Customer advance payments .................................. 169,123 109,135 Checks and drafts outstanding .............................. 84,251 87,808 Accounts payable ........................................... 517,667 495,198 Accrued expenses ........................................... 225,704 148,026 Patronage dividends and equity retirements payable ......... 56,510 72,154 ---------- ---------- Total current liabilities ................................ 1,501,262 1,065,756 Long-term debt .............................................. 483,092 542,243 Other liabilities ........................................... 118,280 99,906 Minority interests in subsidiaries .......................... 89,455 88,261 Commitments and contingencies Equities .................................................... 1,289,638 1,261,153 ---------- ---------- TOTAL LIABILITIES AND EQUITIES ........................... $3,481,727 $3,057,319 ========== ==========
The accompanying notes are an integral part of the consolidated financial statements. F-1 CENEX HARVEST STATES COOPERATIVES AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS FOR THE YEARS ENDED AUGUST 31,
2002 2001 2000 ------------- ------------- ------------- (DOLLARS IN THOUSANDS) REVENUES: Net sales .................................... $7,731,867 $7,753,012 $8,497,850 Patronage dividends .......................... 3,885 5,977 5,494 Other revenues ............................... 109,459 116,254 97,471 ---------- ---------- ---------- 7,845,211 7,875,243 8,600,815 Cost of goods sold ............................ 7,513,369 7,470,203 8,300,494 Marketing, general and administrative ......... 187,292 184,046 155,266 ---------- ---------- ---------- Operating earnings ............................ 144,550 220,994 145,055 Interest ...................................... 42,455 61,436 57,566 Equity income from investments ................ (58,133) (28,494) (28,325) Minority interests ............................ 15,390 35,098 24,546 ---------- ---------- ---------- INCOME BEFORE INCOME TAXES .................... 144,838 152,954 91,268 INCOME TAXES .................................. 18,700 (25,600) 3,880 ---------- ---------- ---------- NET INCOME .................................... $ 126,138 $ 178,554 $ 87,388 ========== ========== ========== DISTRIBUTION OF NET INCOME: Patronage refunds ............................ $ 92,900 $ 128,900 $ 87,400 Unallocated capital reserve .................. 33,238 49,654 (12) ---------- ---------- ---------- Net income ................................. $ 126,138 $ 178,554 $ 87,388 ========== ========== ==========
The accompanying notes are an integral part of the consolidated financial statements. F-2 (This page has been left blank intentionally.) F-3 CENEX HARVEST STATES COOPERATIVES AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF EQUITIES AND COMPREHENSIVE INCOME FOR THE YEARS ENDED AUGUST 31, 2002, 2001 AND 2000
CAPITAL NONPATRONAGE WHEAT EQUITY EQUITY PREFERRED MILLING CERTIFICATES CERTIFICATES STOCK EPUS -------------- -------------- ----------- ---------- (DOLLARS IN THOUSANDS) BALANCES, SEPTEMBER 1, 1999 ................................. $ 912,294 $28,785 $ 9,258 Patronage and equity retirement determination .............. 25,750 Patronage distribution ..................................... 41,182 Equities retired ........................................... (28,615) (82) Equities issued ............................................ 7,921 Other, net ................................................. (178) (194) (12) Comprehensive income: Net income ................................................ Other comprehensive loss .................................. Total comprehensive income ................................. Patronage dividends and equity retirements payable ......... (17,474) --- ---- ---------- ------- -------- BALANCES, AUGUST 31, 2000 ................................... 940,880 28,509 9,246 Patronage and equity retirement determination .............. 17,474 Patronage distribution ..................................... 60,304 Equities retired ........................................... (18,662) (74) Equities issued ............................................ 5,481 Equity Participation Units issued .......................... Equity Participation Units redeemed ........................ (9,066) Other, net ................................................. (120) (277) (180) Comprehensive income: Net income ................................................ Other comprehensive income ................................ Total comprehensive income ................................. Patronage dividends and equity retirements payable ......... (33,484) --- ---- ---------- ------- -------- BALANCES, AUGUST 31, 2001 ................................... 971,873 28,158 -- Patronage and equity retirement determination .............. 33,484 Patronage distribution ..................................... 92,484 Equities retired ........................................... (31,099) (46) Equities issued ............................................ 2,600 Preferred stock issued, net ................................ $9,325 Preferred stock dividends .................................. Other, net ................................................. (106) (339) Comprehensive income: Net income ................................................ Other comprehensive loss .................................. Total comprehensive income ................................. Patronage dividends and equity retirements payable ......... (28,640) --- ---- ---------- ------- ------ -------- BALANCES, AUGUST 31, 2002 ................................... $1,040,596 $27,773 $9,325 $ -- ========== ======= ====== ========
The accompanying notes are an integral part of the consolidated financial statements. F-4 CENEX HARVEST STATES COOPERATIVES AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF EQUITIES AND COMPREHENSIVE INCOME FOR THE YEARS ENDED AUGUST 31, 2002, 2001 AND 2000
OILSEED PROCESSING UNALLOCATED ACCUMULATED OTHER ALLOCATED & REFINING PATRONAGE CAPITAL COMPREHENSIVE CAPITAL TOTAL EPUS REFUNDS RESERVE INCOME (LOSS) RESERVE EQUITIES -------------------- ------------- ------------- ------------------- ---------- ------------- (DOLLARS IN THOUSANDS) $ 4,188 $ 40,250 $115,883 $ (1,170) $8,148 $1,117,636 17,250 43,000 (57,500) (1,588) (17,906) (28,697) 7,921 (6) 453 (28) 35 87,400 (12) 87,388 (1,257) (1,257) ---------- 86,131 ---------- (26,220) (43,694) --------- ---------- -------- --------- ------ ---------- 4,182 61,180 114,736 (2,427) 8,120 1,164,426 26,220 43,694 (87,400) 967 (26,129) (18,736) 5,481 1,045 (1,045) -- (5,227) (14,293) 445 (70) (202) 128,900 49,654 178,554 512 512 ---------- 179,066 ---------- (38,670) (72,154) --------- ---------- -------- --------- ------ ---------- -- 90,230 164,757 (1,915) 8,050 1,261,153 38,670 72,154 (128,900) (3,666) (40,082) (31,145) 2,600 (3,428) 5,897 (240) (240) 100 (345) 92,900 33,238 126,138 (49,982) (49,982) ---------- 76,156 ---------- (27,870) (56,510) --------- ---------- -------- --------- ------ ---------- $ -- $ 65,030 $190,761 $ (51,897) $8,050 $1,289,638 ========= ========== ======== ========= ====== ==========
The accompanying notes are an integral part of the consolidated financial statements. F-5 CENEX HARVEST STATES COOPERATIVES AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE YEARS ENDED AUGUST 31,
2002 2001 2000 ------------- ------------- ------------ (DOLLARS IN THOUSANDS) CASH FLOWS FROM OPERATING ACTIVITIES: Net income ......................................................... $ 126,138 $ 178,554 $ 87,388 Adjustments to reconcile net income to net cash (used in) provided by operating activities: Depreciation and amortization ..................................... 103,986 109,180 92,699 Noncash net income from equity investments ........................ (58,133) (28,494) (28,325) Minority interests ................................................ 15,390 35,098 24,546 Noncash portion of patronage dividends received ................... (2,327) (3,896) (6,825) (Gain) loss on sale of property, plant and equipment .............. (6,418) (13,941) 1,167 Deferred tax expense (benefit) .................................... 4,400 (46,625) (467) Other, net ........................................................ 5,467 (801) (3,130) Changes in operating assets and liabilities: Receivables ...................................................... (32,881) 147,641 (229,067) Inventories ...................................................... (259,209) 37,543 1,717 Other current assets and other assets ............................ (88,941) (24,129) (7,041) Customer credit balances ......................................... (12,025) 1,707 (8,191) Customer advance payments ........................................ 59,988 (22,800) 4,180 Accounts payable and accrued expenses ............................ 93,802 (129,258) 202,980 Other liabilities ................................................ 9,079 13,050 (3,244) ---------- ---------- ---------- Net cash (used in) provided by operating activities ............. (41,684) 252,829 128,387 ---------- ---------- ---------- CASH FLOWS FROM INVESTING ACTIVITIES: Acquisition of property, plant and equipment ....................... (140,169) (97,610) (153,796) Proceeds from disposition of property, plant and equipment ......... 20,205 35,263 7,655 Investments ........................................................ (6,211) (14,247) (35,297) Equity investments redeemed ........................................ 37,689 30,104 41,250 Investments redeemed ............................................... 6,310 1,672 2,638 Changes in notes receivable ........................................ (22,031) 533 600 Acquisitions of intangibles ........................................ (29,501) (7,328) (26,513) Distribution to minority owners .................................... (7,413) (19,256) (21,089) Other investing activities, net .................................... (685) 1,775 (339) ---------- ---------- ---------- Net cash used in investing activities ........................... (141,806) (69,094) (184,891) ---------- ---------- ---------- CASH FLOWS FROM FINANCING ACTIVITIES: Changes in notes payable ........................................... 235,319 (120,731) 20,940 Long-term debt borrowings .......................................... 30,000 116,861 49,914 Principal payments on long-term debt ............................... (17,968) (67,364) (22,502) Changes in checks and drafts outstanding ........................... (3,557) 3,722 35,481 Proceeds from sale of preferred stock, net of expenses ............. 5,897 Preferred stock dividends paid ..................................... (240) Retirements of equity .............................................. (31,145) (18,736) (28,697) Equity Participation Units redeemed ................................ (14,293) Cash patronage dividends paid ...................................... (40,082) (26,129) (17,906) ---------- ---------- ---------- Net cash provided by (used in) financing activities ............. 178,224 (126,670) 37,230 ---------- ---------- ---------- NET (DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS ................................................... (5,266) 57,065 (19,274) CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD .......................................................... 113,458 56,393 75,667 ---------- ---------- ---------- CASH AND CASH EQUIVALENTS AT END OF PERIOD .......................... $ 108,192 $ 113,458 $ 56,393 ========== ========== ==========
The accompanying notes are an integral part of the consolidated financial statements. F-6 CENEX HARVEST STATES COOPERATIVES AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES ORGANIZATION -- Cenex Harvest States Cooperatives (CHS Cooperatives or the Company) is an agricultural cooperative organized for the mutual benefit of its members. Members of the cooperative are located throughout the United States. In addition to grain marketing, wheat milling, oilseed processing and refining and foods, the Company provides its patrons with energy and agronomy products as well as other farm supplies. Sales are both domestic and international. Effective September 1, 2000, the Company's Board of Directors approved a resolution providing for the computation of patronage distributions based on earnings for financial statement purposes rather than federal income tax basis earnings. On December 1, 2000, this resolution was ratified by the Company's members, the by-laws were amended and beginning with fiscal year 2001 patronage distributions have been calculated based on financial statement earnings. The by-laws further provide that an amount of up to 10% of the distributable annual net savings from patronage sources be added to the unallocated capital reserve as determined by the Board of Directors. CONSOLIDATION -- The consolidated financial statements include the accounts of CHS Cooperatives and all of its wholly-owned and majority-owned subsidiaries and limited liability companies, including National Cooperative Refinery Association (NCRA). The effects of all significant intercompany transactions have been eliminated. On September 1, 1999, NCRA and Farmland Industries, Inc. (Farmland) formed Cooperative Refining, LLC (CRLLC), which was established to operate and manage the refineries and related pipelines and terminals of NCRA and Farmland. On December 31, 2000, NCRA and Farmland signed an Agreement of Dissolution and dissolved CRLLC. During 2000, the Company entered into a series of transactions, the result of which was the exchange of its agronomy operations, consisting primarily of its interests in and ownership of the Cenex/Land O'Lakes Agronomy Company and Agro Distribution, LLC and related entities for a 25% equity ownership interest in Agriliance, LLC (Agriliance). Agriliance is a distributor of crop nutrients, crop protection products and other agronomy inputs and services formerly owned by the Company, Land O'Lakes, Inc. (Land O'Lakes) and Farmland. The company accounts for the Agriliance investment under the equity method. During 2002 and 2001, the Company had various other acquisitions, which have been accounted for using the purchase method of accounting. Operating results of the acquisitions are included in the consolidated financial statements since the respective acquisition dates. The respective purchase prices were allocated to the assets and liabilities acquired based upon the estimated fair values. The excess purchase price over the estimated fair values of the net assets acquired has been reported as identifiable intangible assets and goodwill. CASH EQUIVALENTS -- Cash equivalents include short-term highly liquid investments with original maturities of three months or less at date of acquisition. INVENTORIES -- Grain, processed grain, oilseed and processed oilseed are stated at net realizable values which approximates market values. All other inventories are stated at the lower of cost or market. The cost of certain energy inventories (wholesale refined products, crude oil and asphalt) is determined on the last-in, first-out (LIFO) method; all other energy inventories are valued on the first-in, first-out (FIFO) and average cost methods. DERIVATIVE FINANCIAL INSTRUMENTS -- The Company enters into exchange-traded commodity futures and options contracts to hedge its exposure to price fluctuations on energy, grain and oilseed transactions to the extent considered practicable for minimizing risk. Futures and options contracts used for hedging are purchased and sold through regulated commodity exchanges. Fluctuations in inventory valuations, however, may not be completely hedged, due in part to the absence of satisfactory hedging facilities for certain commodities and geographical areas and in part to the Company's assessment of its F-7 CENEX HARVEST STATES COOPERATIVES AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) exposure from expected price fluctuations. The Company also manages its risks by entering into fixed price purchase contracts with preapproved producers and establishing appropriate limits for individual suppliers. Fixed price sales contracts are entered into with customers of acceptable creditworthiness, as internally evaluated. The Company is exposed to loss in the event of nonperformance by the counterparties to the contracts. However, the Company does not anticipate nonperformance by counterparties. Commodity trading in futures and options contracts is a natural extension of cash market trading. The commodity futures and options markets have underlying principles of increased liquidity and longer trading periods than the cash market, and hedging is one method of reducing exposure to price fluctuations. The Company's use of the derivative instruments described above reduces the effects of price volatility, thereby protecting against adverse short-term price movements while somewhat limiting the benefits of short-term price movements. Changes in market value of the derivative instruments described above are recognized in the consolidated statements of operations in the period such changes occur. The fair value of futures and options contracts are determined primarily from quotes listed on regulated commodity exchanges. Fixed price purchase and sales contracts are with various counterparties, and the fair values of such contracts are determined from the market price of the underlying product. At August 31, 2002, the Company's derivative assets and liabilities were $53.8 million and $67.9 million, respectively. COMMODITY PRICE RISK. The Company utilizes futures and options contracts offered through regulated commodity exchanges to reduce risk. The Company is exposed to risk of loss in the market value of inventories and fixed or partially fixed purchase and sale contracts. So as to reduce that risk, the Company generally takes opposite and offsetting positions using future contracts or options. Certain commodities cannot be hedged with futures or options contracts because such contracts are not offered for these commodities by regulated commodity exchanges. Inventories and purchase contracts for those commodities are hedged with forward sales contracts, to the extent practical, so as to arrive at a net commodity position within the formal position limits set by the Company and deemed prudent for each of those commodities. Commodities for which future contracts and options are available are also typically hedged first in this manner, with futures and options used to hedge within position limits that portion not covered by forward contracts. These futures and options contracts and forward purchase and sales contracts used to hedge against price level change risks are effective economic hedges of specified risks, but they are not designated as and accounted for as hedging instruments for accounting purposes. Unrealized gains and losses on futures contracts and options used as economic hedges of grain and oilseed inventories and fixed price contracts are recognized in cost of goods sold for financial reporting. Inventories and fixed price contracts are marked to market so that gains or losses on the derivative contracts are offset by gains or losses on inventories and fixed price contracts during the same accounting period. Through August 31, 2000, unrealized gains and losses on futures contracts and options used to hedge energy inventories and fixed price contracts were deferred until such future contracts and options were closed. Effective September 1, 2000, those gains and losses are recognized as a component of net income for financial reporting. The inventories hedged with these derivatives are valued at lower of cost or market, and effective September 1, 2000, the fixed price contracts are marked to market. Some derivatives related to propane in the Energy segment meet the normal purchase and sales exemption, and thus are not required to be marked to fair value. A 10% adverse change in market prices would not materially affect the Company's results of operations, financial position or liquidity, since the Company's operations have effective economic hedging requirements as a general business practice. F-8 CENEX HARVEST STATES COOPERATIVES AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) INTEREST RATE RISK. The Company manages interest expense using a mix of fixed and floating rate debt. These debt instruments are carried at amounts approximating estimated fair value. Short-term debt used to finance inventories and receivables is represented by notes payable within thirty days or less so that the blended interest rate to the Company for all such notes approximates current market rates. Long-term debt used to finance non-current assets carries various fixed interest rates and is payable at various dates as to minimize the effect of market interest rate changes. The effective interest rate to the Company on fixed rate debt outstanding on August 31, 2002 was approximately 6.4%; a 10% adverse change in market rates would not materially affect the Company's results of operations, financial position or liquidity. In August 2002, the Company entered into interest rate swap instruments related to private placement debt issued on October 18, 2002. These derivative instruments are designated and effective as cash flow hedges for accounting purposes, and the changes in the fair values of these instruments are recorded as a component of other comprehensive income. The Company expects to record operating losses through interest expense of $0.8 million during the year ended August 31, 2003 related to these derivative instruments. FOREIGN CURRENCY RISK. The Company conducts essentially all of its business in U.S. dollars and had minimal risk regarding foreign currency fluctuations on August 31, 2002. Foreign currency fluctuations do, however, impact the ability of foreign buyers to purchase U.S. agricultural products and the competitiveness of U.S. agricultural products compared to the same products offered by alternative sources of world supply. The Company adopted Financial Accounting Standards Board (FASB) Statement of Financial Accounting Standards (SFAS) No. 133, as amended, related to the accounting for derivative transactions and hedging activities, effective September 1, 2000. The effect of the adoption did not have a material effect on the Company's earnings or financial position. INVESTMENTS -- Investments in other cooperatives are stated at cost, plus patronage dividends received in the form of capital stock and other equities. Patronage dividends are recorded at the time qualified written notices of allocation are received. Joint ventures and other investments, in which the Company has significant ownership and influence, but not control, are accounted for in the consolidated financial statements under the equity method of accounting. Investments in other debt and equity securities are considered available for sale financial instruments and are stated at market value, with unrealized amounts included as a component of accumulated other comprehensive income (loss). PROPERTY, PLANT AND EQUIPMENT -- Property, plant and equipment are stated at cost less accumulated depreciation and amortization. Depreciation and amortization are provided on the straight-line method by charges to operations at rates based upon the expected useful lives of individual or groups of assets (primarily 15 to 40 years for land improvements and buildings and 3 to 20 years for machinery, equipment, office and other). The cost and related accumulated depreciation and amortization of assets sold or otherwise disposed of are removed from the related accounts and resulting gains or losses are reflected in operations. Expenditures for maintenance and repairs and minor renewals are expensed, while costs of major renewals and betterments are capitalized. The Company periodically reviews property, plant and equipment and other long-lived assets in order to assess recoverability based on projected income and related cash flows on an undiscounted basis. Should the sum of the expected future net cash flows be less than the carrying value, an impairment loss would be recognized. An impairment loss would be measured by the amount by which the carrying value of the asset exceeds the fair value of the asset. GOODWILL AND OTHER INTANGIBLE ASSETS -- Effective September 1, 2001 the Company adopted the provisions of Statement of Financial Accounting Standards (SFAS) No. 142, "Goodwill and Other F-9 CENEX HARVEST STATES COOPERATIVES AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) Intangible Assets." This statement discontinued the amortization of goodwill and indefinite-lived intangible assets, subject to periodic impairment testing. At August 31, 2001, goodwill (net of accumulated amortization) prior to the adoption of SFAS No. 142, was $29.2 million and was included as a component of other assets. The effect of adopting the new standard will reduce goodwill amortization expense by approximately $2.0 million annually. The Company has completed its transitional impairment testing and no changes to the carrying value of goodwill and other intangible assets were required as a result of the adoption of SFAS No. 142. Subsequent impairment testing will take place annually as well as when a triggering event indicating impairment may have occurred. In addition, the classification of the intangible assets was reviewed, along with the remaining useful lives of intangibles being amortized, and no changes were required. The Company's net income, net of taxes, of retroactive application of the discontinuance of the amortization of goodwill as if SFAS No. 142 had been in effect during the years ended August 31, 2001 and 2000 would have been $181.1 million and $88.5 million, respectively. For the years ended August 31, 2001 and 2000, discontinued amortization expense of goodwill included in other assets would have been $1.9 million and $0.8 million, respectively, and included in equity investments would have been $0.7 million and $0.3 million, respectively. REVENUE RECOGNITION -- Grain and oilseed sales are recorded at time of settlement. All other sales are recognized upon shipment and transfer of title to customers. Amounts billed to a customer in a sale transaction related to shipping and handling are included in sales. Country Operations segment services revenue and rebates are included in other revenues. ENVIRONMENTAL EXPENDITURES -- Liabilities related to remediation of contaminated properties are recognized when the related costs are considered probable and can be reasonably estimated. Estimates of these costs are based on current available facts, existing technology, undiscounted site-specific costs and currently enacted laws and regulations. Recoveries, if any, are recorded in the period in which recovery is considered probable. Liabilities are monitored and adjusted as new facts or changes in law or technology occur. Environmental expenditures are capitalized when such costs provide future economic benefits. INCOME TAXES -- The Company is a nonexempt agricultural cooperative and files a consolidated federal income tax return with its 80% or more owned subsidiaries. The Company is subject to tax on income from nonpatronage sources and undistributed patronage-sourced income. Deferred income taxes reflect the impact of temporary differences between the amounts of assets and liabilities recognized for financial reporting purposes and such amounts recognized for federal and state income tax purposes, at each year end, based on enacted tax laws and statutory tax rates applicable to the periods in which the differences are expected to affect taxable income. Valuation allowances are established, when necessary, to reduce deferred tax assets to the amount expected to be realized. In October 2001, members of NCRA ratified a resolution to compute patronage distributions based on earnings for financial statement purposes rather than amounts reportable for federal income tax purposes, and beginning with the year ended August 31, 2002, NCRA's patronage distributions have been calculated based on financial statement earnings. COMPREHENSIVE INCOME -- The Company accounts for comprehensive income (defined as the change in equity of a business enterprise during a period from sources other than those resulting from investments by owners and distribution to owners) in accordance with Financial Accounting Standards Board (FASB) SFAS No. 130, "Reporting Comprehensive Income." At August 31, 2002, comprehensive income for the Company primarily includes net income and the effects of minimum pension liability adjustments. Total comprehensive income is reflected in the consolidated statements of equities and comprehensive income. F-10 CENEX HARVEST STATES COOPERATIVES AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) USE OF ESTIMATES -- The preparation of 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 and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. RECENT ACCOUNTING PRONOUNCEMENTS -- The FASB issued SFAS No. 143, "Accounting for Asset Retirement Obligations," which addresses financial accounting and reporting for obligations associated with the retirement of tangible long-lived assets and the associated asset retirement costs. SFAS No. 143 is effective for financial statements issued for fiscal years beginning after June 15, 2002. The adoption of this statement does not have a material affect on the Company. The FASB also issued SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets." This statement addresses financial accounting and reporting for the impairment or disposal of long-lived assets. SFAS No. 144 retains and expands upon the fundamental provisions of existing guidance related to the recognition and measurement of the impairment of long-lived assets to be held and used and the measurement of long-lived assets to be disposed of by sale. Generally, the provisions of SFAS No. 144 are effective for financial statements issued for fiscal years beginning after December 15, 2001 and interim periods within those fiscal years. The adoption of this statement does not have a material affect on the Company. The FASB issued SFAS No. 146, "Accounting for Costs Associated with Exit or Disposal Activities." This statement addresses financial accounting and reporting for costs associated with an exit activity that does not involve an entity newly acquired in a business combination or with a disposal activity covered by SFAS No. 144. The costs addressed in SFAS No. 146 include, but are not limited to, termination benefits, costs to terminate a contract that is not a capital lease and costs to consolidate facilities or relocate employees. SFAS No. 146 is effective for exit or disposal activities that are initiated after December 31, 2002. RECLASSIFICATIONS -- Certain amounts in the 2001 financial statements have been reclassified to conform with the current year's presentation. These reclassifications had no effect on previously reported net income, equities and comprehensive income, or cash flows. 2. RECEIVABLES Receivables as of August 31, 2002 and 2001 are as follows:
2002 2001 ----------- ----------- (DOLLARS IN THOUSANDS) Trade ......................................... $717,888 $682,593 Other ......................................... 49,846 28,864 -------- -------- 767,734 711,457 Less allowances for doubtful accounts ......... 26,156 25,317 -------- -------- $741,578 $686,140 ======== ========
F-11 CENEX HARVEST STATES COOPERATIVES AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 2. RECEIVABLES (CONTINUED) All international sales are denominated in U.S. dollars. International sales for the years ended August 31, 2002, 2001 and 2000 are as follows:
2002 2001 2000 --------- --------- --------- (DOLLARS IN MILLIONS) Africa ................ $ 135 $ 138 $ 191 Asia .................. 407 403 552 Europe ................ 282 255 304 North America ......... 298 317 324 South America ......... 100 101 119 ------ ------ ------ $1,222 $1,214 $1,490 ====== ====== ======
3. INVENTORIES Inventories as of August 31, 2002 and 2001 are as follows:
2002 2001 ----------- ----------- (DOLLARS IN THOUSANDS) Grain and oilseed ................... $393,095 $237,498 Energy .............................. 229,981 163,710 Feed and farm supplies .............. 91,138 76,570 Processed grain and oilseed ......... 36,264 28,648 Other ............................... 9,185 4,017 -------- -------- $759,663 $510,443 ======== ========
As of August 31, 2002, the Company valued approximately 26% of inventories, primarily related to energy, using the lower of cost, determined on the LIFO method, or market (28% as of August 31, 2001). If the FIFO method of accounting for these inventories had been used, inventories would have been higher than the reported amount by $40.5 million and $34.0 million at August 31, 2002 and 2001, respectively. 4. INVESTMENTS Investments as of August 31, 2002 and 2001 are as follows: 2002 2001 -------- -------- (DOLLARS IN THOUSANDS) Cooperatives: CF Industries, Inc. ............................. $152,996 $152,996 National Bank for Cooperatives (CoBank) ......... 30,069 33,080 Ag Processing, Inc. ............................. 25,797 24,967 Land O'Lakes, Inc. .............................. 26,232 24,604 Joint ventures: Ventura Foods, LLC .............................. 108,981 101,089 United Country Brands, LLC ...................... 86,175 74,457 Tacoma Export Marketing Company ................. 8,414 11,638 Other ............................................ 57,943 45,122 -------- -------- $496,607 $467,953 ======== ======== F-12 CENEX HARVEST STATES COOPERATIVES AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 4. INVESTMENTS (CONTINUED) In March 2000, the Company purchased an additional 10% interest in Ventura Foods, LLC, its consumer products and packaging joint venture, for $25.6 million, of which $13.8 million was goodwill. The Company has a 50% interest in this joint venture. The following provides summarized information for Ventura Foods, LLC, balance sheets as of August 31, 2002 and 2001 and statements of operations for the twelve months ended August 31, 2002, 2001 and 2000: 2002 2001 ----------- ----------- (DOLLARS IN THOUSANDS) Current assets .................. $171,084 $159,062 Non-current assets .............. 231,045 221,000 Current liabilities ............. 133,230 114,883 Non-current liabilities ......... 90,819 104,144 2002 2001 2000 ------------- ----------- ----------- (DOLLARS IN THOUSANDS) Net sales ............ $1,013,475 $925,962 $896,941 Gross profit ......... 181,217 161,405 143,394 Net income ........... 75,368 71,148 55,115 Effective January 1, 2000, CHS Cooperatives, Farmland and Land O'Lakes created Agriliance, a distributor of crop nutrients, crop protection products and other agronomy inputs and services. At formation, Agriliance managed the agronomy marketing operations of CHS Cooperatives, Farmland and Land O'Lakes, with the Company exchanging the right to use its agronomy operations for 26.455% of the results of the jointly managed operations. In March 2000, the Company sold 1.455% of its economic interest in Agriliance to Land O'Lakes, resulting in a gain of $7.4 million. On July 31, 2000, the Company exchanged its ownership interest in the Cenex/Land O'Lakes Agronomy Company and in Agro Distribution, LLC, with a total investment of $64.7 million, for a 25% equity interest in Agriliance. Agriliance ownership also includes Farmland (25%) and Land O'Lakes (50%). The interests of the Company and Farmland are held through equal ownership in United Country Brands, LLC, a joint venture holding company whose sole operations consist of the ownership of a 50% interest in Agriliance. Equity in the joint venture was recorded at historical carrying value of its ownership in Cenex/Land O'Lakes Agronomy Company and Agro Distribution, LLC and no gain or loss was recorded on the exchange. In July 2000, Agriliance secured its own financing, which is without recourse to the Company. Also in July 2000, Agriliance purchased the net working capital related to agronomy operations from each of its member owners, consisting primarily of trade accounts receivable and inventories, net of accounts payable. The following provide summarized information for Agriliance balance sheets as of August 31, 2002 and 2001 and statements of operations for the years ended August 31, 2002 and 2001: 2002 2001 ----------- ----------- (DOLLARS IN THOUSANDS) Current assets .................. $922,958 $956,496 Non-current assets .............. 134,247 158,107 Current liabilities ............. 700,903 802,341 Non-current liabilities ......... 107,960 110,964 F-13 CENEX HARVEST STATES COOPERATIVES AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 4. INVESTMENTS (CONTINUED) 2002 2001 ------------- ------------- (DOLLARS IN THOUSANDS) Net sales ........................ $3,625,849 $4,072,248 Earnings from operations ......... 57,604 50,423 Net income ....................... 47,044 25,053 The Company's contribution of its equity interest in Agriliance occurred on July 31, 2000, and as such, net sales, gross profits and net income for the one month ended August 31, 2000 have been excluded from the above summarized information of statements of operations, as they were not material. Disclosure of the fair value of financial instruments to which the Company is a party includes estimates and assumptions which may be subjective in nature and involve uncertainties and matters of significant judgment and therefore cannot be determined with precision. Financial instruments are carried at amounts that approximate estimated fair value. Investments in cooperatives and joint ventures have no quoted market prices and, as such, it is not practicable to estimate their fair value. Various agreements with other owners of investee companies and a majority-owned subsidiary set out parameters whereby CHS Cooperatives may buy and sell additional interests in those companies, upon the occurrence of certain events, at fair values determinable as set forth in the specific agreements. 5. PROPERTY, PLANT AND EQUIPMENT A summary of property, plant and equipment as of August 31, 2002 and 2001 is as follows:
2002 2001 ------------ ------------ (DOLLARS IN THOUSANDS) Land and land improvements ............................. $ 63,045 $ 55,092 Buildings .............................................. 371,107 348,081 Machinery and equipment ................................ 1,470,475 1,434,598 Office and other ....................................... 62,144 56,740 Construction in progress ............................... 71,540 38,723 ---------- ---------- 2,038,311 1,933,234 Less accumulated depreciation and amortization ......... 980,890 909,362 ---------- ---------- $1,057,421 $1,023,872 ========== ==========
In January 2002, the Company formed a limited liability company (LLC) with Cargill, Incorporated to engage in wheat flour milling and processing. The Company holds a 24% interest in the entity, which is known as Horizon Milling, LLC (Horizon). The Company is leasing its wheat milling facilities and related equipment to Horizon under operating lease agreements. The book value of the leased milling assets at August 31, 2002 was $104.9 million, net of accumulated depreciation of $25.3 million. For the years ended August 31, 2002, 2001 and 2000, the Company capitalized interest of $2.1 million, $1.2 million and $2.7 million, respectively, related to long-term construction projects. F-14 CENEX HARVEST STATES COOPERATIVES AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 6. OTHER ASSETS Other assets as of August 31, 2002 and 2001 are as follows:
2002 2001 ---------- ---------- (DOLLARS IN THOUSANDS) Goodwill ............................................................. $ 27,926 $ 29,153 Non-compete covenants, less accumulated amortization of $2,896 and $1,329, respectively ................................................ 11,204 1,765 Customer lists, less accumulated amortization of $3,511 and $1,946, respectively ........................................................ 8,447 8,095 Other intangible assets, less accumulated amortization of $2,462 and $1,513, respectively ................................................ 15,795 239 Prepaid pension and other benefit assets ............................. 54,230 100,727 Deferred tax asset ................................................... 50,544 44,316 Notes receivable ..................................................... 4,822 5,629 Other ................................................................ 4,354 4,534 -------- -------- $177,322 $194,458 ======== ========
Intangible assets subject to amortization are amortized on a straight-line basis over the number of years that approximate their respective useful lives (ranging from 2 to 15 years). The straight-line method of amortization reflects an appropriate allocation of the cost of the intangible assets to earnings in proportion to the amount of economic benefit obtained by the Company in each reporting period. Amortization expense for the year ended August 31, 2002 was $4.2 million. The estimated amortization expense related to intangible assets subject to amortization for the next five years will approximate $4.0 million annually. Through Country Energy, LLC, formerly a joint venture with Farmland, the Company marketed refined petroleum products including gasoline, diesel fuel, propane and lubricants under the Cenex brand. On November 30, 2001, the Company purchased the wholesale energy business of Farmland, as well as all interest in Country Energy, LLC. Based on estimated fair values, $26.4 million of the purchase price was allocated to intangible assets, primarily trademarks, tradenames and non-compete agreements. The intangible assets have a weighted-average life of approximately 12 years. The Company also entered into an exclusive two-year supply agreement to purchase, at prevailing market prices, all of the refined fuels production from Farmland's Coffeyville, Kansas facility. F-15 CENEX HARVEST STATES COOPERATIVES AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 7. NOTES PAYABLE AND LONG-TERM DEBT Notes payable and long-term debt as of August 31, 2002 and 2001 consisted of the following:
INTEREST RATES AT AUGUST 31, 2002 2002 2001 ------------------- ----------- ----------- (DOLLARS IN THOUSANDS) Notes payable (a)(g) .............................. 2.32% to 2.78% $332,514 $ 97,195 ======== ======== Long-term debt: Revolving term loans from cooperative and other banks, payable in installments through 2009, when the balance is due (b)(c)(g) ......... 2.16% to 13.00% $254,962 $236,611 Private placement, payable in equal installments beginning in 2008 through 2013 (d)(g) ..................................... 6.81% 225,000 225,000 Private placement, payable in equal installments beginning in 2005 through 2011 (e)(g) ..................................... 7.43% to 7.90% 80,000 80,000 Industrial Revenue Bonds, payable in installments through 2011 (f) ................... 5.23% to 12.97% 7,444 12,806 Other notes and contracts ........................ 4.00% to 14.00% 4,718 5,580 -------- -------- Total long-term debt ............................. 572,124 559,997 Less current portion ............................. 89,032 17,754 -------- -------- Long-term portion ................................ $483,092 $542,243 ======== ========
Weighted average interest rates at August 31: 2002 2001 ---------- ---------- Short-term debt .......... 2.58% 4.18% Long-term debt ........... 6.38% 6.91% ------------------ (a) The Company finances its working capital needs through short-term lines of credit with a syndication of banks. The Company has a 364-day credit facility of $550.0 million, all of which is committed, and of which $332.0 million was outstanding on August 31, 2002. In addition to this short-term line of credit, the Company has a 364-day credit facility dedicated to NCRA with a syndication of banks in the amount of $30.0 million, all of which is committed, with no amounts outstanding on August 31, 2002. Other miscellaneous notes payable totaled $0.5 million at August 31, 2002. (b) The Company established a $200.0 million five-year revolving credit facility with a syndication of banks. On August 31, 2002, the Company had an outstanding balance of $75.0 million. (c) The Company established a long-term credit agreement which committed $200.0 million of long-term borrowing capacity to the Company through May 31, 1999, of which $164.0 million was drawn before the expiration date of that commitment. On August 31, 2002, $144.3 million was outstanding. NCRA term loans of $18.0 million are collateralized by NCRA's investment in CoBank. (d) The Company entered into a private placement with several insurance companies for long-term debt in the amount of $225.0 million. (e) In January 2001, the Company entered into a note purchase and private shelf agreement with Prudential Insurance Company. A long-term note was issued for $25.0 million. A subsequent note for $55.0 million was issued in March 2001, related to the private shelf facility. F-16 CENEX HARVEST STATES COOPERATIVES AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 7. NOTES PAYABLE AND LONG-TERM DEBT (CONTINUED) (f) Industrial Revenue Bonds in the amount of $2.7 million are collateralized by property, plant and equipment, primarily energy refinery equipment, with a cost of approximately $152.0 million, less accumulated depreciation of approximately $115.2 million on August 31, 2002. (g) Restrictive covenants under various agreements have requirements for maintenance of minimum working capital levels and other financial ratios. The fair value of long-term debt approximates book value as of August 31, 2002 and 2001. The aggregate amount of long-term debt payable as of August 31, 2002 is as follows (dollars in thousands): 2003 ............... $ 89,032 2004 ............... 15,079 2005 ............... 34,511 2006 ............... 34,938 2007 ............... 41,709 Thereafter ......... 356,855 -------- $572,124 ======== On October 18, 2002, the Company entered into a private placement with several insurance companies for long-term debt in the amount of $175.0 million, which was layered into two series. The first series of $115.0 million has an interest rate of 4.96% and will be repaid in equal semi-annual installments of approximately $8.8 million during the years 2007 through 2013. The second series of $60.0 million has an interest rate of 5.60% and will be repaid in equal semi-annual installments of approximately $4.6 million during fiscal years 2012 through 2018. The proceeds were used to pay down the Company's short-term debt. 8. INCOME TAXES As a result of the Company's by-law changes during 2001, and the by-law changes of its majority-owned subsidiary (NCRA) in 2002, to distribute patronage based on financial statement earnings (see Note 1), the statutory rate applied to the cumulative differences between financial statement earnings and tax basis earnings, has been changed. In connection with this change the Company recorded a deferred tax benefit of $10.9 million as of August 31, 2002 and $34.2 million as of August 31, 2001. The $10.9 million deferred tax benefit recorded as a result of the change in patronage distribution by NCRA as of August 31, 2002 has been offset by a $10.9 million NCRA valuation allowance. An additional $6.2 million of deferred tax benefit generated by NCRA was also offset by a valuation allowance. The provision for income taxes for the years ended August 31, 2002, 2001 and 2000 is as follows: 2002 2001 2000 ------------ ------------ --------- (DOLLARS IN THOUSANDS) Current ..................... $ 14,300 $ 21,025 $4,347 Deferred .................... (12,700) (49,025) (467) Valuation allowance ......... 17,100 2,400 --------- --------- ------ Income taxes ................ $ 18,700 $ (25,600) $3,880 ========= ========= ====== F-17 CENEX HARVEST STATES COOPERATIVES AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 8. INCOME TAXES (CONTINUED) The tax effect of temporary differences that give rise to significant portions of deferred tax assets and liabilities as of August 31, 2002 and 2001 is as follows:
2002 2001 ------------ ---------- (DOLLARS IN THOUSANDS) Deferred tax assets: Accrued expenses and valuation reserves ...................... $ 49,236 $ 42,704 Postretirement health care and deferred compensation ......... 32,671 24,842 Property, plant and equipment ................................ 11,532 9,570 Alternative minimum tax credit and patronage loss carryforward ................................................ 6,993 4,540 Other ........................................................ 12,439 12,885 --------- -------- Total deferred tax assets ................................... 112,871 94,541 --------- -------- Deferred tax liabilities: Pension, including minimum liability ......................... 2,635 9,536 Equity method investments .................................... 20,482 27,893 Other ........................................................ 730 1,314 --------- -------- Total deferred tax liabilities ................................ 23,847 38,743 --------- -------- Deferred tax assets valuation reserve ......................... (19,466) (2,400) --------- -------- Net deferred tax asset ........................................ $ 69,558 $ 53,398 ========= ========
As of August 31, 2002, net deferred tax assets of $19.0 million and $50.5 million are included in current assets and other assets, respectively ($9.1 million and $44.3 million, respectively, as of August 31, 2001). At August 31, 2002, NCRA recognized a valuation allowance for the entire tax benefit associated with its net deferred tax assets, as it is considered more likely than not, based on the weight of available information, that the future tax benefits related to these items will not be realized. At August 31, 2002, NCRA's net deferred tax assets of approximately $19.5 million were comprised of deferred tax assets of $23.4 million and deferred tax liabilities of $3.9 million. Deferred tax assets are comprised of basis differences related to inventories, investments, lease obligations, accrued liabilities and certain federal and state tax credits. NCRA files a separate tax return and, as such, these items must be assessed independently of the Company's deferred tax assets when determining recoverability. At August 31, 2001, NCRA also recorded a valuation allowance of $2.4 million to account for uncertainties regarding the recoverability of certain state tax credits. The reconciliation of the statutory federal income tax rate to the effective tax rate for the years ended August 31, 2002, 2001 and 2000 is as follows:
2002 2001 2000 ---------- ------------ ---------- Statutory federal income tax rate ............................ 35.0% 35.0% 35.0% State and local income taxes, net of federal income tax benefit ................................................. 3.9 3.9 3.9 Patronage earnings ........................................... (25.0) (32.8) (37.3) Tax effect of changes in deferred patronage .................. 4.4 Change in patronage determination ............................ (7.5) (22.4) Export activities at rates other than the U.S. statutory rate ......................................... (1.9) Deferred tax asset valuation allowance ....................... 11.8 1.6 Rate changes on deferred tax assets and liabilities .......... (2.5) Other ........................................................ (3.4) (2.0) 0.8 ----- ----- ----- Effective tax rate ........................................... 12.9% (16.7)% 4.3% ===== ===== =====
F-18 CENEX HARVEST STATES COOPERATIVES AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 8. INCOME TAXES (CONTINUED) The principal differences between financial statement income and taxable income for the years ended August 31, 2002, 2001 and 2000 are as follows:
2002 2001 2000 ----------- ------------- ------------ (DOLLARS IN THOUSANDS) Income before income taxes ................... $ 144,838 $ 152,954 $ 91,268 Financial reporting/tax differences: ......... Environmental reserves ...................... 1,939 4,453 (728) Oil and gas activities, net ................. 1,540 (22,230) 2,600 Energy inventory market reserves ............ (933) (2,441) (19) Pension and compensation .................... (21,491) 8,981 Investments in other entities ............... 1,898 26,495 Export activities ........................... (7,141) Other, net .................................. (2,291) 10,038 3,255 Patronage refund provisions ................. (92,900) (128,900) (87,400) --------- ---------- --------- Taxable income ............................... $ 25,459 $ 49,350 $ 8,976 ========= ========== =========
9. EQUITIES In accordance with the by-laws and by action of the Board of Directors, annual net savings from patronage sources are distributed to consenting patrons following the close of each year, and are based on amounts using financial statement earnings. The cash portion of the patronage distribution is determined annually by the Board of Directors, with the balance issued in the form of capital equity certificates. Annual net savings from sources other than patronage may be added to the unallocated capital reserve or, upon action by the Board of Directors, allocated to members in the form of nonpatronage equity certificates. Inactive direct members and patrons and active direct members and patrons age 61 and older on June 1, 1998 are eligible for redemption of their capital equity certificates at age 72 or death. For other active direct members and patrons and member cooperatives, equities will be redeemed annually as determined by the Board of Directors. On May 31, 1997, the Company completed an offering for the sale of Equity Participation Units (EPUs) in its Wheat Milling Defined Business Unit and its Oilseed Processing and Refining Defined Business Unit to qualified subscribers. Qualified subscribers were identified as Defined Members or representatives of Defined Members who were persons or associations of producers actually engaged in the production of agricultural products. Subscribers were allowed to purchase a portion of their EPUs by exchanging existing patronage certificates. The purchasers of EPUs had the right and obligation to deliver annually the number of bushels of wheat or soybeans equal to the number of units held. Unit holders participated in the net patronage-sourced income from operations of the applicable Defined Business Unit as patronage refunds. Retirements of patrons' equities attributable to EPUs, were at the discretion of the Board of Directors, and it was the Board's goal to retire such equity on a revolving basis seven years after declaration. During 2001, the Company's Board of Directors adopted a resolution to issue, at no charge, to each Defined Member of the Oilseed Processing and Refining Defined Business Unit an additional 1/4 EPU, for each EPU held, due to increased crush volume. In August 2001, the CHS Cooperatives Board of Directors approved and consummated a plan to end the Defined Investment Program. The Company redeemed all of the EPUs and allocated the assets F-19 CENEX HARVEST STATES COOPERATIVES AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 9. EQUITIES (CONTINUED) of the Oilseed Processing and Refining and Wheat Milling Defined Business Units to the Company as provided in the plan. The amounts redeemed to the Oilseed Processing and Refining and Wheat Milling Defined Member EPU holders were $5.2 million and $9.1 million, respectively. Due to loss carry-forwards incurred by the Wheat Milling Defined Business Unit, the plan also provided for the cancellation of all outstanding Preferred Capital Certificates issued to the Wheat Milling EPU holders, totaling $0.2 million. The plan further provided to the Oilseed Processing and Refining Defined Member EPU holders for the redemption of all outstanding Preferred Capital Certificates issued of $0.2 million and a 100% cash distribution during 2002 for the patronage refunds earned for the fiscal year ended August 31, 2001. The Board of Directors has authorized the sale and issuance of up to 50,000,000 shares of 8% Preferred Stock at a price of $1.00 per share. The Company filed a registration statement on Form S-2 with the Securities and Exchange Commission registering the Preferred Stock. The registration statement was declared effective on October 31, 2001 and sales of the Preferred Stock were $9.3 million (9,325,374 shares) through August 31, 2002. Cash dividends are paid at a rate of 8% per annum per share and are fully cumulative. There is no sinking fund requirement and the Company may redeem all or any portion of the preferred stock upon 30 days written notice at $1.00 per share. Expenses related to the issuance of the Preferred Stock were $3.4 million through the year ended August 31, 2002 and have been included as a component of unallocated capital reserve. 10. EMPLOYEE BENEFIT PLANS The Company has various pension and other defined benefit and defined contribution plans, in which substantially all employees may participate. Financial information on changes in benefit obligation and plan assets funded and balance sheet status as of August 31, 2002 and 2001 is as follows:
PENSION BENEFITS OTHER BENEFITS ------------------------- ----------------------- 2002 2001 2002 2001 ----------- ----------- ---------- ---------- (DOLLARS IN THOUSANDS) Change in benefit obligation: Benefit obligation at beginning of period ......... $ 253,564 $ 258,059 $ 22,667 $ 21,439 Service cost ...................................... 10,443 8,506 557 566 Interest cost ..................................... 18,559 18,487 1,586 1,569 Plan participants contributions ................... 189 Plan amendments ................................... 2,383 6 (1,005) Transfers ......................................... 3,677 (2,387) Actuarial loss (gain) ............................. 2,764 (2,842) 1,716 1,902 Assumption change ................................. 2,534 638 Settlements ....................................... 643 Benefits paid ..................................... (22,979) (29,442) (2,438) (1,804) --------- --------- -------- -------- Benefit obligation at end of period ............... $ 268,411 $ 253,564 $ 24,915 $ 22,667 ========= ========= ======== ========
F-20 CENEX HARVEST STATES COOPERATIVES AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 10. EMPLOYEE BENEFIT PLANS (CONTINUED)
PENSION BENEFITS OTHER BENEFITS ----------------------------- ----------------------------- 2002 2001 2002 2001 ------------- ------------- ------------- ------------- (DOLLARS IN THOUSANDS) Change in plan assets: Fair value of plan assets at beginning of period ..... $ 230,121 $ 266,896 Actual loss on plan assets ........................... (14,810) (16,206) Company contributions ................................ 5,554 11,669 $ 2,249 $ 1,804 Participants contributions ........................... 189 Net transfers ........................................ 3,677 (2,796) Benefits paid ........................................ (22,979) (29,442) (2,438) (1,804) --------- --------- --------- --------- Fair value of plan assets at end of period ........... $ 201,563 $ 230,121 $ -- $ -- ========= ========= ========= ========= Funded status ........................................ $ (66,848) $ (23,443) $ (24,915) $ (22,667) Employer contributions after measurement date 31,394 1,262 269 264 Unrecognized actuarial loss (gain) ................... 85,082 47,368 (3,505) (6,363) Unrecognized transition (asset) obligation ........... (708) 10,197 11,133 Unrecognized prior service cost ...................... 10,569 9,639 (1,336) (1,534) --------- --------- --------- --------- Prepaid benefit cost (accrued) ....................... $ 60,197 $ 34,118 $ (19,290) $ (19,167) ========= ========= ========= ========= Amounts recognized on balance sheets consist of: Prepaid benefit cost ................................. $ 43,918 Accrued benefit liability ............................ $ (23,837) (12,214) $ (19,290) $ (19,167) Intangible asset ..................................... 7,995 1,055 Minority interests ................................... 6,195 Accumulated other comprehensive loss ................. 69,844 1,359 --------- --------- --------- --------- Net amounts recognized ............................... $ 60,197 $ 34,118 $ (19,290) $ (19,167) ========= ========= ========= =========
For measurement purposes, a 7.5% annual rate of increase in the per capita cost of covered health care benefits was assumed for the year ended August 31, 2002. The rate was assumed to decrease gradually to 6.0% for 2004 and remain at that level thereafter. Components of net periodic benefit costs for the years ended August 31, 2002, 2001 and 2000 are as follows:
PENSION BENEFITS OTHER BENEFITS ------------------------------------------ ----------------------------------- 2002 2001 2000 2002 2001 2000 ------------ ------------ ------------ ---------- ---------- --------- (DOLLARS IN THOUSANDS) Components of net periodic benefit cost: Service cost ............................... $ 10,443 $ 8,506 $ 8,777 $ 557 $ 566 $ 657 Interest cost .............................. 18,559 18,487 18,058 1,586 1,569 1,470 Expected return on assets .................. (21,386) (22,855) (20,485) Prior service cost amortization ............ 1,314 1,193 1,182 (197) (131) (77) Actuarial loss (gain) amortization ......... 1,387 375 (530) (505) (538) (604) Transition amount amortization ............. (708) (861) (1,120) 936 936 936 Other ...................................... (22) --------- --------- --------- ------ ------ ------ Net periodic benefit cost .................. $ 9,609 $ 4,845 $ 5,882 $2,377 $2,380 $2,382 ========= ========= ========= ====== ====== ====== Weighted-average assumptions: Discount rate .............................. 7.10% 7.30% 7.50% 7.10% 7.30% 7.50% Expected return on plan assets ............. 9.00% 9.00% 9.00% N/A N/A N/A Rate of compensation increase .............. 5.00% 5.00% 5.00% 5.00% 5.00% 5.00%
F-21 CENEX HARVEST STATES COOPERATIVES AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 10. EMPLOYEE BENEFIT PLANS (CONTINUED) The aggregate projected benefit obligation, accumulated benefit obligation and fair value of plan assets for pension plans with accumulated benefit obligations in excess of plan assets were as follows as of August 31, 2002 and 2001: 2002 2001 ----------- ---------- (DOLLARS IN THOUSANDS) Projected benefit obligation ........... $268,411 $23,247 Accumulated benefit obligation ......... 256,795 18,599 Fair value of plan assets .............. 201,563 6,385 Assumed health care cost trend rates have a significant effect on the amounts reported for the health care plans. A one-percentage point change in the assumed health care cost trend rates would have the following effects:
1% POINT 1% POINT INCREASE DECREASE ---------- ----------- (DOLLARS IN THOUSANDS) Effect on total of service and interest cost components ......... $ 177 $ (202) Effect on postretirement benefit obligation ..................... 1,435 (1,210)
The Company provides defined life insurance and health care benefits for certain retired employees. The plan is contributory based on years of service and family status, with retiree contributions adjusted annually. The Company has other contributory defined contribution plans covering substantially all employees. Total contributions by the Company to these plans were $11.0 million, $6.1 million and $4.6 million, for the years ended August 31, 2002, 2001 and 2000, respectively. 11. SEGMENT REPORTING The Company manages five business segments, which are based on products and services, and are Agronomy, Energy, Country Operations, Grain Marketing, and Processed Grains and Foods. Reconciling Amounts represent the elimination of sales between segments. Due to cost allocations and intersegment activity, management does not represent that these segments, if operated independently, would report the income before income taxes and other financial information as presented. Segment information for the years ended August 31, 2002, 2001 and 2000 is as follows:
PROCESSED CORPORATE COUNTRY GRAIN GRAINS AND AND RECONCILING AGRONOMY ENERGY OPERATIONS MARKETING FOODS OTHER AMOUNTS TOTAL ---------- ---------- ---------- ----------- ---------- ---------- ---------- ---------- (DOLLARS IN THOUSANDS) For the year ended August 31, 2002: Net sales ................ $2,657,689 $1,474,553 $3,787,322 $ 496,084 $ (683,781) $7,731,867 Patronage dividends ...... $ (89) 458 2,572 497 260 $ 187 3,885 Other revenues ........... 6,392 80,789 21,902 (1,469) 1,845 109,459 ---------- ---------- ---------- ---------- ---------- ---------- ---------- ---------- (89) 2,664,539 1,557,914 3,809,721 494,875 2,032 (683,781) 7,845,211 Cost of goods sold ....... 2,489,352 1,471,422 3,778,838 457,538 (683,781) 7,513,369 Marketing, general and administrative .......... 8,957 66,731 47,995 22,213 36,930 4,466 187,292 Interest ................. (1,403) 16,875 13,851 4,807 9,514 (1,189) 42,455 Equity (income) loss from investments ............. (13,425) 1,166 (283) (4,257) (41,331) (3) (58,133) Minority interests ....... 14,604 786 15,390 ---------- ----------- ---------- ---------- ---------- ---------- ---------- ---------- Income (loss) before income taxes ............ $ 5,782 $ 75,811 $ 24,143 $ 8,120 $ 32,224 $ (1,242) $ -- $ 144,838 ========== =========== ========== ========== ========== ========== ========== ==========
F-22 CENEX HARVEST STATES COOPERATIVES AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 11. SEGMENT REPORTING (CONTINUED)
PROCESSED CORPORATE COUNTRY GRAIN GRAINS AND AND RECONCILING AGRONOMY ENERGY OPERATIONS MARKETING FOODS OTHER AMOUNTS TOTAL ---------- ---------- ---------- ---------- ---------- ---------- ----------- ---------- (DOLLARS IN THOUSANDS) (DOLLARS IN THOUSANDS) For the year ended August 31, 2002: Goodwill ................ $ 4,059 $ 262 $ 23,605 $ 27,926 ========== ========== ========== ========== Capital expenditures .... $ 54,576 $ 34,305 $ 14,851 $ 35,144 $ 1,293 $ 140,169 ========== ========== ========== ========== ========== ========== Depreciation and amortization ........... $ 1,247 $ 58,701 $ 21,214 $ 6,235 $ 13,436 $ 3,153 $ 103,986 ========== ========== ========== ========== ========== ========== ========== Total identifiable assets at August 31, 2002 ..... $ 242,015 $1,305,828 $ 799,711 $ 481,232 $ 439,942 $ 212,999 $3,481,727 ========== ========== ========== ========== ========== ========== ========== For the year ended August 31, 2001: Net sales ............... $2,781,243 $1,577,268 $3,514,314 $ 662,726 $ (782,539) $7,753,012 Patronage dividends ..... $ 196 712 3,683 840 339 $ 207 5,977 Other revenues .......... 4,036 80,479 22,964 (238) 9,013 116,254 ---------- ---------- ---------- ---------- ---------- ---------- ----------- ---------- 196 2,785,991 1,661,430 3,538,118 662,827 9,220 (782,539) 7,875,243 Cost of goods sold ...... 2,549,099 1,569,884 3,514,575 619,184 (782,539) 7,470,203 Marketing, general and administrative ......... 8,503 48,432 53,417 22,396 44,870 6,428 184,046 Interest ................ (4,529) 25,097 15,695 8,144 13,026 4,003 61,436 Equity (income) loss from investments ............ (7,360) 4,081 (246) (4,519) (35,505) 15,055 (28,494) Minority interests ...... 34,713 385 35,098 ---------- ---------- ---------- ---------- ---------- ---------- ----------- ---------- Income (loss) before income taxes ........... $ 3,582 $ 124,569 $ 22,295 $ (2,478) $ 21,252 $ (16,266) $ -- $ 152,954 ========== ========== ========== ========== ========== ========== =========== ========== Goodwill ................ $ 5,175 $ 373 $ 23,605 $ 29,153 ========== ========== ========== ========== Capital expenditures .... $ 38,984 $ 32,448 $ 3,715 $ 20,485 $ 1,978 $ 97,610 ========== ========== ========== ========== ========== ========== Depreciation and amortization ........... $ 1,250 $ 55,343 $ 21,738 $ 4,917 $ 22,304 $ 3,628 $ 109,180 ========== ========== ========== ========== ========== ========== ========== Total identifiable assets at August 31, 2001 ..... $ 230,051 $1,154,036 $ 679,053 $ 345,696 $ 430,871 $ 217,612 $3,057,319 ========== ========== ========== ========== ========== ========== ========== For the year ended August 31, 2000: Net sales ............... $ 808,659 $2,959,622 $1,409,892 $3,453,807 $ 584,052 $ (718,182) $8,497,850 Patronage dividends ..... 224 311 3,830 861 100 $ 168 5,494 Other revenues .......... 5,817 2,792 68,436 15,440 (10) 4,996 97,471 ---------- ---------- ---------- ---------- ---------- ---------- ----------- ---------- 814,700 2,962,725 1,482,158 3,470,108 584,142 5,164 (718,182) 8,600,815 Cost of goods sold ...... 764,744 2,862,715 1,404,120 3,439,863 547,234 (718,182) 8,300,494 Marketing, general and administrative ......... 20,832 43,332 44,136 21,412 21,462 4,092 155,266 Interest ................ (3,512) 27,926 12,782 8,701 9,851 1,818 57,566 Equity loss (income) from investments ............ 4,336 (856) (1,007) (6,452) (24,367) 21 (28,325) Minority interests ...... 24,443 103 24,546 ---------- ---------- ---------- ---------- ---------- ---------- ----------- ---------- Income (loss) before income taxes ........... $ 28,300 $ 5,165 $ 22,024 $ 6,584 $ 29,962 $ (767) $ -- $ 91,268 ========== ========== ========== ========== ========== ========== =========== ========== Capital expenditures .... $ 65,017 $ 38,514 $ 12,096 $ 36,494 $ 1,675 $ 153,796 ========== ========== ========== ========== ========== ========== Depreciation and amortization ........... $ 106 $ 52,017 $ 21,717 $ 3,803 $ 11,440 $ 3,616 $ 92,699 ========== ========== ========== ========== ========== ========== ==========
12. COMMITMENTS AND CONTINGENCIES ENVIRONMENTAL -- The Company is required to comply with various environmental laws and regulations incidental to its normal business operations. In order to meet its compliance requirements, the Company establishes reserves for the future costs of remediation of identified issues, which are F-23 CENEX HARVEST STATES COOPERATIVES AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 12. COMMITMENTS AND CONTINGENCIES (CONTINUED) included in cost of goods sold in the consolidated statements of operations. Additional costs for matters, which may be identified in the future, cannot be presently determined. The resolution of any such matters may have an impact on the Company's consolidated financial results for a particular reporting period; however, management believes any such matters will not have a material adverse effect on the consolidated financial position, results of operations or cash flows of the Company. In connection with certain refinery upgrades and enhancements that are necessary in order to comply with existing environmental regulations, the Company expects to incur additional capital expenditures of approximately $340 million in relation to these projects over the next four years, primarily at the NCRA refinery. The Company anticipates funding these projects with a combination of cash flows from operations and additional indebtedness. OTHER LITIGATION AND CLAIMS -- The Company is involved as a defendant in various lawsuits, claims and disputes which are in the normal course of the Company's business. The resolution of any such matters may have an impact on the Company's consolidated financial results for a particular reporting period; however, management believes any resulting liability will not have a material adverse effect on the consolidated financial position, results of operations or cash flows of the Company. GRAIN STORAGE -- As of August 31, 2002 and 2001, the Company stored grain and processed grain products for third parties totaling $148.0 million and $177.0 million, respectively. Such stored commodities and products are not the property of the Company and therefore are not included in the Company's inventories. GUARANTEES -- The Company is a guarantor for lines of credit for related companies totaling up to $86.2 million, of which $45.1 million was outstanding as of August 31, 2002. All outstanding loans with respective creditors are current as of August 31, 2002. LEASE COMMITMENTS -- The Company leases approximately 1,700 rail cars with remaining lease terms of one to 10 years. In addition, the Company has commitments under other operating leases for various refinery, manufacturing and transportation equipment, vehicles and office space. Some leases include purchase options at not less than fair market value at the end of the leases. Total rental expense for all operating leases, net of rail car mileage credits received from the railroad and sublease income was $30.2 million, $35.5 million and $38.0 million for the years ended August 31, 2002, 2001 and 2000, respectively. Mileage credits and sublease income were $9.5 million, $11.0 million and $10.6 million for the years ended August 31, 2002, 2001 and 2000, respectively. Minimum future lease payments, required under noncancellable operating leases as of August 31, 2002, are as follows:
EQUIPMENT RAIL CARS VEHICLES AND OTHER TOTAL ----------- ---------- ----------- ---------- (DOLLARS IN THOUSANDS) 2003 ........................................ $ 9,100 $ 9,436 $14,417 $32,953 2004 ........................................ 7,091 6,992 10,116 24,199 2005 ........................................ 5,525 5,183 5,286 15,994 2006 ........................................ 2,018 3,321 3,561 8,900 2007 ........................................ 1,042 1,657 2,433 5,132 Thereafter .................................. 4,025 255 515 4,795 ------- ------- ------- ------- Total minimum future lease payments ......... $28,801 $26,844 $36,328 $91,973 ======= ======= ======= =======
F-24 CENEX HARVEST STATES COOPERATIVES AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 13. SUPPLEMENTAL CASH FLOW AND OTHER INFORMATION Additional information concerning supplemental disclosures of cash flow activities for the years ended August 31, 2002, 2001 and 2000 is as follows:
2002 2001 2000 ------------ ------------ ------------ (DOLLARS IN THOUSANDS) Net cash paid during the period for: Interest ......................................... $ 44,231 $ 63,034 $ 57,062 Income taxes ..................................... 27,965 11,709 3,785 Other significant noncash transactions: (Distributions)/contributions of inventories of minority interests .............................. (54,399) 54,399 Capital equity certificates issued in exchange for elevator properties ............................. 1,842 5,481 7,921 Equity Participation Units issued ................ 1,045 Accrual of patronage dividends and equity retirements payable ............................. (56,510) (72,154) (43,694) Other comprehensive (loss) income ................ (49,982) 512 (1,257)
14. RELATED PARTIES TRANSACTIONS As of August 31, 2002, the Company had related party transactions, which consisted of sales of $550.0 million, purchases of $502.4 million, receivables of $21.2 million and payables of $18.3 million with its equity investees. These related party transactions were primarily with Agriliance, CF Industries, Inc., Horizon Milling, Tacoma Export Marketing Company and Ventura Foods, LLC. 15. COMPREHENSIVE INCOME The components of comprehensive income for the years ended August 31, 2002, 2001 and 2000 are as follows:
2002 2001 2000 ----------- ----------- ---------- (DOLLARS IN THOUSANDS) Net income .............................................. $ 126,138 $178,554 $ 87,388 Additional minimum pension liability, net of taxes ..... (48,797) (15) 153 Financial instruments, net of taxes .................... (548) 527 (1,410) Cash flow hedges, net of taxes ......................... (637) --------- -------- -------- Comprehensive income .................................... $ 76,156 $179,066 $ 86,131 ========= ======== ========
The components of accumulated other comprehensive loss as of August 31, 2002 and 2001 are as follows:
2002 2001 ---------- --------- (DOLLARS IN THOUSANDS) Additional minimum pension liability, net of taxes ......... $50,051 $1,254 Financial instruments, net of taxes ........................ 1,209 661 Cash flow hedges, net of taxes ............................. 637 ------- ------ Accumulated other comprehensive loss ....................... $51,897 $1,915 ======= ======
F-25 REPORT OF INDEPENDENT ACCOUNTANTS To the Board of Directors and Members and Patrons of Cenex Harvest States Cooperatives: In our opinion, the accompanying consolidated balance sheets and the related consolidated statements of operations, of equities and comprehensive income and of cash flows present fairly, in all material respects, the financial position of Cenex Harvest States Cooperatives and subsidiaries as of August 31, 2002 and 2001, and the results of their operations and their cash flows for each of the three years in the period ended August 31, 2002, in conformity with accounting principles generally accepted in the United States of America. These financial statements are the responsibility of the Company's management; our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these statements in accordance with auditing standards generally accepted in the United States of America, which require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. PRICEWATERHOUSECOOPERS, LLP October 18, 2002 Minneapolis, Minnesota F-26 INDEPENDENT AUDITORS' REPORT Members Committee of Ventura Foods, LLC: We have audited the accompanying consolidated balance sheets of Ventura Foods, LLC and subsidiary (the "Company") as of March 31, 2002 and 2001, and the related consolidated statements of income, members' capital, and cash flows for the year ended March 31, 2002, the three months ended March 31, 2001, and the years ended December 31, 2000 and 1999. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of Ventura Foods, LLC and subsidiary as of March 31, 2002 and 2001, and the results of their operations and their cash flows for the year ended March 31, 2002, the three months ended March 31, 2001, and the years ended December 31, 2000 and 1999 in conformity with accounting principles generally accepted in the United States of America. As discussed in Note 2 to the consolidated financial statements, the Company changed its method of accounting for start-up activities in 1999. DELOITTE & TOUCHE LLP Los Angeles, California June 19, 2002 F-27 VENTURA FOODS, LLC AND SUBSIDIARY CONSOLIDATED BALANCE SHEETS MARCH 31, 2002 AND 2001
2002 2001 -------------- --------------- ASSETS (NOTE 4) CURRENT ASSETS: Cash and cash equivalents (Note 2) .......................................... $ 9,300,000 $ 14,150,000 Trade receivables, net of allowance for doubtful accounts of $1,543,000 and $2,000,000 at 2002 and 2001, respectively (Notes 2, 4 and 5) ............... 57,139,000 56,368,000 Inventories (Notes 2, 4 and 5) .............................................. 62,799,000 66,680,000 Prepaid expenses and other current assets ................................... 2,283,000 1,490,000 Due from Wilsey Foods, Inc. (Note 5) ........................................ 47,000 Derivative contract asset (Note 2) .......................................... 13,298,000 12,193,000 ------------ ------------ TOTAL CURRENT ASSETS ...................................................... 144,819,000 150,928,000 ------------ ------------ PROPERTY (Notes 2 and 4): Land, buildings, and improvements ........................................... 98,840,000 96,082,000 Machinery and equipment ..................................................... 129,133,000 120,932,000 Construction-in-progress .................................................... 6,489,000 7,581,000 Other property .............................................................. 10,494,000 8,798,000 ------------ ------------ Total ..................................................................... 244,956,000 233,393,000 Less accumulated depreciation and amortization .............................. 95,052,000 84,178,000 ------------ ------------ Property, net ............................................................. 149,904,000 149,215,000 GOODWILL, Net of amortization of $18,087,000 and $15,180,000 at 2002 and 2001, respectively (Notes 2 and 3) .......................................... 43,156,000 46,063,000 TRADEMARKS, Net of amortization of $8,814,000 and $5,862,000 at 2002 and 2001, respectively (Notes 2 and 4) .......................................... 19,991,000 22,838,000 DEFERRED COMPENSATION PLAN TRUST (Note 6) .................................... 14,240,000 OTHER ASSETS, Net of amortization of $4,181,000 and $3,813,000 (Note 2) ...... 4,879,000 5,304,000 ------------ ------------ TOTAL ....................................................................... $376,989,000 $374,348,000 ============ ============ LIABILITIES AND MEMBERS' CAPITAL CURRENT LIABILITIES: Accounts payable (Note 5) ................................................... $ 52,045,000 $ 56,536,000 Accrued liabilities (Note 5) ................................................ 25,784,000 22,891,000 Deferred compensation obligations (Note 6) .................................. 9,660,000 Dividends payable ........................................................... 9,550,000 18,625,000 Bank lines of credit (Note 4) ............................................... 8,000,000 5,000,000 Current portion of long-term debt (Note 4) .................................. 12,758,000 12,603,000 Current portion of long-term liability -- Wilsey Foods, Inc. (Note 1) ....... 491,000 978,000 Derivative contract liability (Note 2) ...................................... 4,120,000 4,818,000 ------------ ------------ Total current liabilities ................................................. 112,748,000 131,111,000 ------------ ------------ LONG-TERM DEBT (Note 4) ...................................................... 97,178,000 109,936,000 ------------ ------------ DEFERRED COMPENSATION OBLIGATIONS (Note 6) ................................... 16,347,000 1,557,000 ------------ ------------ Total liabilities ......................................................... 226,273,000 242,604,000 COMMITMENTS AND CONTINGENCIES (Notes 6 and 7) ................................ MEMBERS' CAPITAL ............................................................. 150,716,000 131,744,000 ------------ ------------ TOTAL ....................................................................... $376,989,000 $374,348,000 ============ ============
See notes to consolidated financial statements. F-28 VENTURA FOODS, LLC AND SUBSIDIARY CONSOLIDATED STATEMENTS OF INCOME YEAR ENDED MARCH 31, 2002 AND THE THREE MONTHS ENDED MARCH 31, 2001 AND THE YEARS ENDED DECEMBER 31, 2000 AND 1999
THREE MONTHS YEAR ENDED YEAR ENDED ENDED DECEMBER 31, MARCH 31, MARCH 31, ----------------------------------- 2002 2001 2000 1999 ---------------- ---------------- ---------------- ---------------- NET SALES (Notes 2 and 5) ..................... $ 965,728,000 $ 215,187,000 $ 890,042,000 $ 918,043,000 COST OF GOODS SOLD (Notes 2 and 5) .............................. 792,689,000 177,748,000 744,282,000 798,891,000 ------------- ------------- ------------- ------------- GROSS PROFIT ................................. 173,039,000 37,439,000 145,760,000 119,152,000 ------------- ------------- ------------- ------------- OPERATING EXPENSES: Selling, general, and administrative (Notes 2 and 5) ............................. 92,034,000 20,121,000 78,145,000 69,127,000 Amortization of intangibles (Note 2) ......... 6,227,000 1,581,000 6,431,000 6,379,000 ------------- ------------- ------------- ------------- Total operating expenses ................... 98,261,000 21,702,000 84,576,000 75,506,000 ------------- ------------- ------------- ------------- OPERATING INCOME .............................. 74,778,000 15,737,000 61,184,000 43,646,000 INTEREST EXPENSE, Net ......................... 7,474,000 2,071,000 9,585,000 10,146,000 OTHER INCOME (Note 7) ......................... (3,182,000) (702,000) (5,907,000) (2,413,000) ------------- ------------- ------------- ------------- INCOME BEFORE CUMULATIVE EFFECT OF ACCOUNTING CHANGE ......................... 70,486,000 14,368,000 57,506,000 35,913,000 CUMULATIVE EFFECT OF ACCOUNTING CHANGE (Note 2) .............................. 563,000 ------------- ------------- ------------- ------------- NET INCOME .................................... $ 70,486,000 $ 14,368,000 $ 57,506,000 $ 35,350,000 ============= ============= ============= =============
See notes to consolidated financial statements. F-29 VENTURA FOODS, LLC AND SUBSIDIARY CONSOLIDATED STATEMENTS OF MEMBERS' CAPITAL YEAR ENDED MARCH 31, 2002 AND THE THREE MONTHS ENDED MARCH 31, 2001 AND THE YEARS ENDED DECEMBER 31, 2000 AND 1999
CENEX HARVEST WILSEY STATES FOODS, INC. COOPERATIVES TOTAL --------------- ---------------- ----------------- BALANCE, JANUARY 1, 1999 ............... $ 48,371,000 $ 32,248,000 $ 80,619,000 Net income ............................ 21,210,000 14,140,000 35,350,000 Contributions ......................... 12,000,000 8,000,000 20,000,000 Dividends ............................. (14,266,000) (9,511,000) (23,777,000) ------------- ------------- ------------- BALANCE, DECEMBER 31, 1999 ............. 67,315,000 44,877,000 112,192,000 Net income ............................ 30,593,000 26,913,000 57,506,000 Transfer of interest (Note 1) ......... (11,775,000) 11,775,000 Dividends ............................. (23,288,000) (20,720,000) (44,008,000) ------------- ------------- ------------- BALANCE, DECEMBER 31, 2000 ............. 62,845,000 62,845,000 125,690,000 Net income ............................ 7,184,000 7,184,000 14,368,000 Dividends ............................. (4,157,000) (4,157,000) (8,314,000) ------------- ------------- ------------- BALANCE, MARCH 31, 2001 ................ 65,872,000 65,872,000 131,744,000 Net income ............................ 35,243,000 35,243,000 70,486,000 Dividends ............................. (25,757,000) (25,757,000) (51,514,000) ------------- ------------- ------------- BALANCE, MARCH 31, 2002 ................ $ 75,358,000 $ 75,358,000 $ 150,716,000 ============= ============= =============
See notes to consolidated financial statements. F-30 VENTURA FOODS, LLC AND SUBSIDIARY CONSOLIDATED STATEMENTS OF CASH FLOWS YEAR ENDED MARCH 31, 2002 AND THE THREE MONTHS ENDED MARCH 31, 2001 AND THE YEARS ENDED DECEMBER 31, 2000 AND 1999
THREE MONTHS YEAR ENDED YEAR ENDED ENDED DECEMBER 31, MARCH 31, MARCH 31, --------------------------------- 2002 2001 2000 1999 ---------------- --------------- ---------------- --------------- CASH FLOWS FROM OPERATING ACTIVITIES: Net income ............................................. $ 70,486,000 $ 14,368,000 $ 57,506,000 $ 35,350,000 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization ........................ 12,186,000 2,833,000 10,829,000 9,740,000 Amortization of intangibles .......................... 6,227,000 1,581,000 6,431,000 6,379,000 Loss (gain) on disposal/impairment of assets ......... 324,000 128,000 (139,000) 2,576,000 Derivative contract asset ............................ (1,803,000) (7,375,000) Gain on deferred compensation plan trust assets ........................................ (264,000) Changes in operating assets and liabilities: Trade receivables ................................... (771,000) 980,000 (359,000) 6,198,000 Inventories ......................................... 3,881,000 5,089,000 (3,246,000) 4,600,000 Prepaid expenses and other current assets ........... (793,000) 330,000 234,000 2,442,000 Accounts payable .................................... (4,491,000) (2,943,000) (4,654,000) (1,023,000) Accrued liabilities ................................. 2,893,000 (2,540,000) 2,499,000 5,932,000 Deferred compensation obligations ................... 5,130,000 (1,767,000) 6,747,000 3,835,000 Due from/to affiliates .............................. 47,000 1,000 293,000 (266,000) ------------- ------------ ------------- ------------- Net cash provided by operating activities ......... 93,052,000 10,685,000 76,141,000 75,763,000 ------------- ------------ ------------- ------------- CASH FLOWS FROM INVESTING ACTIVITIES: Acquisition of property ................................ (13,268,000) (4,869,000) (13,037,000) (17,841,000) Proceeds from sale of property ......................... 69,000 23,000 1,021,000 51,000 Acquisitions, net of cash acquired (Note 3) ............ (5,312,000) (50,028,000) Acquisition of trademarks .............................. (47,000) Investment in rabbi trust .............................. (13,976,000) Other assets ........................................... (48,000) 67,000 (201,000) (1,355,000) ------------- ------------ ------------- ------------- Net cash used in investing activities ............. (27,223,000) (4,779,000) (17,576,000) (69,173,000) ------------- ------------ ------------- ------------- CASH FLOWS FROM FINANCING ACTIVITIES: Borrowings of long-term debt ........................... 35,000,000 Repayment of long-term debt ............................ (12,603,000) (554,000) (12,417,000) (9,490,000) Net borrowings (payments) on line of credit ............ 3,000,000 5,000,000 (15,000,000) (26,000,000) Payment to Wilsey Foods, Inc. (Note 1) ................. (487,000) (487,000) (487,000) Payment of bank loan fees .............................. (105,000) Dividends paid ......................................... (60,589,000) (38,539,000) (23,274,000) Contributions received ................................. 20,000,000 ------------- ------------ ------------- ------------- Net cash (used in) provided by financing activities ............................. (70,679,000) 3,959,000 (65,956,000) (4,356,000) ------------- ------------ ------------- ------------- NET (DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS ................................... (4,850,000) 9,865,000 (7,391,000) 2,234,000 CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD .................................... 14,150,000 4,285,000 11,676,000 9,442,000 ------------- ------------ ------------- ------------- CASH AND CASH EQUIVALENTS, END OF PERIOD .......................................... $ 9,300,000 $ 14,150,000 $ 4,285,000 $ 11,676,000 ============= ============ ============= ============= SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION -- Cash paid during the period for interest ......................... $ 8,129,000 $ 653,054 $ 10,181,000 $ 10,296,000 ============= ============ ============= =============
See notes to consolidated financial statements. F-31 VENTURA FOODS, LLC AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEAR ENDED MARCH 31, 2002 AND THE THREE MONTHS ENDED MARCH 31, 2001 AND THE YEARS ENDED DECEMBER 31, 2000 AND 1999 1. GENERAL MATTERS Ventura Foods, LLC and its subsidiary (the "Company") is a processor and distributor of edible oils used in food preparation and a packager of food products. The Company sells its products to national and regional restaurant chains, food wholesalers, and retail chains. The Company was formed pursuant to a Joint Venture Agreement (the "Agreement") dated August 30, 1996 between Wilsey Foods, Inc. ("Wilsey") and Cenex Harvest States Cooperatives ("Cenex") whereby substantially all the assets and liabilities of Wilsey and Holsum Foods (a division of Cenex) were transferred and assigned, with certain exclusions, to the Company. Wilsey is a majority-owned subsidiary of Mitsui & Co., Ltd. From the period of inception through March 31, 2000, Wilsey and Cenex owned 60 percent and 40 percent of the Company, respectively. On March 31, 2000, Wilsey sold a 10 percent interest in the Company to Cenex. Accordingly, Wilsey and Cenex each own 50 percent of the Company. At the formation date, a liability equal to the net deferred income tax liability of Wilsey at August 30, 1996 was assumed by the Company and was included in long-term liability -Wilsey Foods, Inc. The amount is payable in five equal annual installments of $487,000 plus a final installment of $491,000. 2. ACCOUNTING POLICIES BASIS OF PRESENTATION AND PRINCIPLES OF CONSOLIDATION -- The consolidated financial statements include the accounts of Ventura Foods, LLC and its 100 percent-owned subsidiary, Ventura Jets, Inc. All material intercompany transactions have been eliminated. FISCAL YEAR-END -- During 2001, the Company changed its fiscal year-end to March 31. Prior to such change, the Company's fiscal year-end had been December 31. CUMULATIVE EFFECT OF ACCOUNTING CHANGE -- In connection with the adoption of Statement of Position 98-5, REPORTING ON THE COSTS OF START-UP ACTIVITIES, on January 1, 1999, the Company charged $563,000 of previously deferred start-up costs to expense. CASH AND CASH EQUIVALENTS -- The Company considers all highly liquid investments purchased with a maturity of three months or less to be cash equivalents. INVENTORIES -- Inventories consist of the following at March 31, 2002 and 2001: 2002 2001 -------------- -------------- Bulk oil .......................... $17,654,000 $24,642,000 Finished goods .................... 27,696,000 24,692,000 Ingredients and supplies .......... 17,449,000 17,346,000 ----------- ----------- Total ............................ $62,799,000 $66,680,000 =========== =========== Inventories are accounted for at the lower of cost or market, using the first-in first-out method. DERIVATIVE FINANCIAL INSTRUMENTS -- The Company's use of derivative financial instruments is limited to forwards, futures, and certain other delivery contracts as discussed below. The Company enters into these contracts to limit its exposure to price volatility of various food oils that are critical to its processing and distribution activities. It is the Company's policy to remain substantially hedged with respect to edible oil product price risk; derivative contracts are used to maintain this hedged position. Forward purchase and sales contracts with established market participants as well as exchange traded futures contracts are entered into in amounts necessary to protect against price changes on raw materials needed for the Company's food oil processing and distribution activities. The Company also enters into purchase and sales commitments with major suppliers and customers at a specified premium or discount from a future market price ("Basis Contracts"). Additionally, the Company's policies do not permit F-32 VENTURA FOODS, LLC AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) YEAR ENDED MARCH 31, 2002 AND THE THREE MONTHS ENDED MARCH 31, 2001 AND THE YEARS ENDED DECEMBER 31, 2000 AND 1999 2. ACCOUNTING POLICIES (CONTINUED) speculative trading of such contracts. All of these qualify as derivatives under Statement of Financial Accounting Standards ("SFAS") No. 133, ACCOUNTING FOR DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES, and are stated at market value. Changes in market value are recognized in the consolidated statements of income, through cost of sales, in the periods such changes occur. The adoption of SFAS No. 133, on January 1, 2001, did not have a significant impact on the Company's results of operations, as the Company historically recorded its financial instruments at market value. Prior to the adoption of SFAS No. 133, the market value of futures contracts, basis contracts, and forward purchase and sales contracts were recorded as a component of inventory. Beginning with the adoption of SFAS No. 133, the market value of these contracts is now recorded separately on the balance sheet as derivative contract assets or liabilities. These contracts have maturities of less than one year. The following summarizes the Company's various derivative contracts outstanding at March 31, 2002 and 2001: NET UNREALIZED FORWARD CONTRACTS AND COMMITMENTS POUNDS GAIN (LOSS) ----------------------------------- ------------ --------------- (IN THOUSANDS) MARCH 31, 2002 Forward purchases ................. 490,500 $ 7,873 Forward sales ..................... 454,100 (1,117) Basis purchase .................... 390,300 2,304 Basis sales ....................... 62,600 (303) Futures contracts ................. 96,100 421 --------- -------- 1,493,600 $ 9,178 ========= ======== MARCH 31, 2001 Forward purchases ................. 391,800 $ 3,836 Forward sales ..................... 395,200 741 Basis purchase .................... 1,316,200 1,989 Basis sales ....................... 151,500 163 Futures contracts ................. 117,900 646 --------- -------- 2,372,600 $ 7,375 ========= ======== The fair value of futures contracts are determined from quotes listed on the Chicago Board of Trade or other market makers. Forward purchase and sales contracts are with various counterparties, and the fair values of such contracts are determined from the market price of the underlying product. The Company is exposed to loss in the event of nonperformance by the other parties to the contracts. However, the Company does not anticipate nonperformance by counterparties. PROPERTY AND DEPRECIATION -- Property is stated at cost, and depreciation is provided for using the straight-line method over the estimated useful lives of the assets, as follows: Buildings ................................. 40 years Leasehold improvements .................... 3 - 19 years Machinery and equipment ................... 10 - 25 years Other fixed assets ........................ 3 - 20 years F-33 VENTURA FOODS, LLC AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) YEAR ENDED MARCH 31, 2002 AND THE THREE MONTHS ENDED MARCH 31, 2001 AND THE YEARS ENDED DECEMBER 31, 2000 AND 1999 2. ACCOUNTING POLICIES (CONTINUED) FAIR VALUE OF FINANCIAL INSTRUMENTS -- The Company estimates the fair value of financial instruments using the following methods and assumptions: ACCOUNTS RECEIVABLE AND ACCOUNTS PAYABLE -- The carrying amounts approximate fair value, due to the short maturities of these instruments. LINES OF CREDIT -- The carrying amounts approximate fair value, as the interest rates are based upon variable reference rates. LONG-TERM DEBT -- Based on the borrowing rates currently available to the Company for bank loans with similar terms and remaining maturities, the carrying amounts approximate fair value. FUTURES CONTRACTS -- The fair value of futures contracts (used for hedging purposes) is determined from quotes listed principally on the Chicago Board of Trade. CONCENTRATION OF CREDIT RISK -- During the year ended March 31, 2002 and the three months ended March 31, 2001 and the years ended December 31, 2000 and 1999, net sales to one customer were 22 percent, 22 percent, 21 percent, and 18 percent of total net sales, respectively. This customer represents approximately 19 percent and 17 percent of trade receivables at March 31, 2002 and 2001, respectively. The Company performs ongoing credit evaluations of its customers and maintains an allowance for potential credit losses. The Company maintains cash deposits with various financial institutions. The Company periodically evaluates the credit standing of these financial institutions and has not sustained any credit losses relating to such balances. MARKETABLE SECURITIES -- The Company's marketable securities are composed of equity securities that have been classified as trading securities. The equity securities are carried at fair market value based upon quoted market prices of those investments at March 31, 2002. Unrealized gains and losses on equity securities are recognized in net income. GOODWILL AND TRADEMARKS -- The Company's goodwill relates to various acquisitions of businesses and is being amortized using the straight-line method over periods ranging from 15 to 20 years. Trademarks are amortized using the straight-line method over 10 to 15 years. Patents and other intangibles are amortized using the straight-line method over 1 to 15 years (see "Recent Accounting Pronouncements"). IMPAIRMENT OF LONG-LIVED ASSETS -- Long-lived assets, including identifiable intangibles and goodwill, are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. In performing the review for recoverability, future cash flows expected to result from the use of the asset and its eventual disposition are estimated. If the sum of the expected future cash flows (undiscounted and without interest charges) is less than the carrying amount of the asset, an impairment loss is recorded under the discounted future cash flow method. Impairment losses of $1,277,000 were recognized during 1999. ADVERTISING COSTS -- The Company expenses advertising costs in the period incurred. For the year ended March 31, 2002 and the three months ended March 31, 2001 and the years ended December 31, 2000 and 1999, the Company incurred advertising expenses of approximately $7,100,000, $1,300,000, $6,100,000, and $4,500,000, respectively. INCOME TAXES -- The Company is a limited liability company and has no liability for federal and state income taxes. Income is taxed to the members based on their allocated share of taxable income or loss. However, certain states tax the income of limited liability companies. The Company's liability for such state income taxes is not significant. F-34 VENTURA FOODS, LLC AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) YEAR ENDED MARCH 31, 2002 AND THE THREE MONTHS ENDED MARCH 31, 2001 AND THE YEARS ENDED DECEMBER 31, 2000 AND 1999 2. ACCOUNTING POLICIES (CONTINUED) REVENUE RECOGNITION -- Revenue is recognized after the related product has been shipped and title has transferred to the customer. Sales are presented net of discounts and sales allowances. USE OF ESTIMATES -- The preparation of 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 and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. RECLASSIFICATIONS -- Certain reclassifications have been made to the prior periods' financial statements to conform to the 2002 presentation. RECENT ACCOUNTING PRONOUNCEMENTS -- In June 2001, the Financial Accounting Standards Board ("FASB") approved the issuance of SFAS No. 141, BUSINESS COMBINATIONS, and SFAS No. 142, GOODWILL AND OTHER INTANGIBLE ASSETS. SFAS No. 141 requires that the purchase method of accounting be used for all business combinations initiated after June 30, 2001. SFAS No. 142 changes the accounting for goodwill from an amortization method to an impairment-only approach. Amortization of goodwill, including goodwill recorded in business combinations occurring prior to June 30, 2001, will cease upon adoption of this statement. In addition, the standard includes provisions for the reclassification of certain existing recognized intangibles as goodwill, reassessment of the useful lives of existing recognized intangibles, reclassification of certain intangibles out of previously reported goodwill, and the identification of reporting units for purposes of assessing potential future impairments of goodwill. Under SFAS Nos. 141 and 142, goodwill and other intangibles are initially assessed for impairment upon adoption of the statements, with subsequent assessments required annually and when there is reason to suspect that their values have been diminished or impaired and with any corresponding write-downs recognized as necessary. The Company adopted SFAS No. 141 on July 1, 2001. The adoption did not have a material impact on its consolidated financial statements. The Company adopted SFAS No. 142 on April 1, 2002. SFAS No. 142 requires the Company to complete a transitional goodwill and other intangible assets impairment test. The Company does not believe that the results of the impairment tests will have a material impact on its consolidated financial statements. Annual goodwill amortization of approximately $4,000,000 ceased upon the adoption of SFAS No. 142. Amortization of other intangible assets for the year ended March 31, 2002 and the three months ended March 31, 2001 and the years ended December 31, 2000 and 1999 was approximately $1,900,000, $430,000, $1,750,000 and $1,700,000, respectively. In June 2001, the FASB issued SFAS No. 143, ACCOUNTING FOR ASSET RETIREMENT OBLIGATIONS, which addresses financial accounting and reporting for obligations associated with the retirement of tangible long-lived assets and the associated asset retirement costs. This statement will be adopted as required in fiscal year 2004. The Company is currently assessing, but has not yet determined, the impact this statement will have on its consolidated financial statements. In July 2001, the FASB issued SFAS No. 144, ACCOUNTING FOR THE IMPAIRMENT OR DISPOSAL OF LONG-LIVED ASSETS, which addresses financial accounting and reporting for the impairment or disposal of long-lived assets and supersedes SFAS No. 121, ACCOUNTING FOR THE IMPAIRMENT OF LONG-LIVED ASSETS AND FOR LONG-LIVED ASSETS TO BE DISPOSED OF, and the accounting and reporting provisions of Accounting Principles Board Opinion No. 30, REPORTING THE RESULTS OF OPERATIONS - REPORTING THE EFFECTS OF DISPOSAL OF A SEGMENT OF A BUSINESS, AND EXTRAORDINARY, UNUSUAL AND INFREQUENTLY OCCURRING EVENTS AND TRANSACTIONS. This statement retains the requirements of SFAS No. 121 to (a) recognize an impairment loss only if the carrying amount of a long-lived asset is not recoverable from its undiscounted cash flows F-35 VENTURA FOODS, LLC AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) YEAR ENDED MARCH 31, 2002 AND THE THREE MONTHS ENDED MARCH 31, 2001 AND THE YEARS ENDED DECEMBER 31, 2000 AND 1999 2. ACCOUNTING POLICIES (CONTINUED) and (b) measure an impairment loss as the difference between the carrying amount and fair value of the asset, and establishes a single accounting model, based on the framework established in SFAS No. 121, for long-lived assets to be disposed of by sale. This statement will be adopted as required in fiscal year 2003. The Company is currently assessing, but has not yet determined, the impact this statement will have on its consolidated financial statements. In November 2001, the Emerging Issues Task Force ("EITF") issued EITF Issue No. 01-09, ACCOUNTING FOR CONSIDERATION GIVEN BY A VENDOR TO A CUSTOMER OR A RESELLER OF THE VENDOR'S PRODUCTS, which addresses the accounting for consideration given by a vendor to a customer or a reseller of the vendor's products. This new guidance provides that consideration from a vendor to a reseller is generally presumed to be a reduction of the selling prices of the vendor's products and therefore should be characterized as a reduction of revenue when recognized in the vendor's income statement. This statement will be adopted as required in fiscal year 2003. The Company is currently assessing, but has not yet determined, the impact this guidance will have on its consolidated financial statements. 3. ACQUISITIONS During 2000, the Company acquired substantially all the assets and liabilities of Sona and Hollen for $5,740,000. Sona and Hollen is a portion packing company located in Los Alamitos, California. The acquisition has been accounted for as a purchase, and accordingly, the purchase price has been allocated based on the estimated fair values of the assets acquired. The excess of the purchase price over the fair value of the assets acquired, approximately $4,276,000, was recorded as goodwill and had been amortized using a 15-year life. The following is a summary of the assets acquired at estimated fair market value: Inventories ............................... $ 637,000 Prepaid expenses and other assets ......... 208,000 Property and equipment .................... 600,000 Trademark ................................. 19,000 Goodwill .................................. 4,276,000 ---------- Net assets of business acquired ........... $5,740,000 ========== On January 11, 1999, the Company acquired substantially all the assets and liabilities of Sunnyland Refining Company ("Sunnyland") from its parent, Kane-Miller Corp, for $53.2 million in cash. Sunnyland is a manufacturer and national distributor of margarine products located in Birmingham, Alabama. The acquisition has been accounted for as a purchase, and accordingly, the purchase price has been allocated based on the estimated fair values of the assets acquired. The excess of the purchase price over the fair value of the assets acquired, approximately $38.8 million, was recorded as goodwill and has been amortized using a 15-year life. F-36 VENTURA FOODS, LLC AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) YEAR ENDED MARCH 31, 2002 AND THE THREE MONTHS ENDED MARCH 31, 2001 AND THE YEARS ENDED DECEMBER 31, 2000 AND 1999 3. ACQUISITIONS (CONTINUED) The following is a summary of the assets acquired and liabilities assumed at estimated fair market value: Cash ...................................... $ 3,201,000 Accounts receivable ....................... 6,513,000 Inventories ............................... 2,577,000 Prepaid expenses and other assets ......... 486,000 Property and equipment .................... 12,445,000 Goodwill .................................. 38,837,000 ------------- Assets acquired ........................... 64,059,000 ------------- Accounts payable .......................... (7,653,000) Accrued liabilities ....................... (3,177,000) ------------- Liabilities assumed ....................... (10,830,000) ------------- Net assets of business acquired ........... $ 53,229,000 ============= 4. LINES OF CREDIT AND LONG-TERM DEBT LINES OF CREDIT -- At March 31, 2002, the Company had a revolving line-of-credit agreement with a banking group to provide for borrowings of up to an aggregate of $72,000,000. Borrowings at March 31, 2002 and 2001 under such lines were $8,000,000 and $5,000,000, respectively. The interest rates applicable to borrowings are based, at the option of the Company, at a London Interbank Offered Rate ("LIBOR") or a term federal funds rate ("TFFR") option. The weighted-average rate at March 31, 2002 and 2001 was 2.24 percent and 5.67 percent, respectively. The credit agreement is subject to renewal annually with the banking group. LONG-TERM DEBT -- At March 31, 2002 and 2001, balances outstanding on long-term debt were $109,936,000 and $122,539,000, respectively, and represent term loans with a banking group. The interest rate applicable to these term loans is based, at the option of the Company, at a TFFR-based, LIBOR-based, or a fixed rate option. The weighted-average interest rate on borrowings at March 31, 2002 and 2001 was 6.59 percent and 6.83 percent, respectively. The term loans are collateralized by substantially all property, equipment, and intellectual property rights, and the lines of credit are collateralized by substantially all trade receivables and inventories of the Company. The loan agreements contain various covenants, including compliance with tangible net worth (as defined) and other financial ratios, restrictions on the payment of dividends, and restrictions on the incurrence of additional debt. Annual maturities of long-term debt at March 31, 2002 are as follows: 2003 ........................... $ 12,758,000 2004 ........................... 74,223,000 2005 ........................... 2,799,000 2006 ........................... 2,987,000 2007 ........................... 3,187,000 Thereafter ..................... 13,982,000 ------------ Total .......................... 109,936,000 Less current portion ........... 12,758,000 ------------ Long-term debt ................. $ 97,178,000 ============ F-37 VENTURA FOODS, LLC AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) YEAR ENDED MARCH 31, 2002 AND THE THREE MONTHS ENDED MARCH 31, 2001 AND THE YEARS ENDED DECEMBER 31, 2000 AND 1999 5. TRANSACTIONS WITH AFFILIATES At March 31, 2002, the Company had a receivable balance of $47,000 due from Wilsey for reimbursement of expenses paid by the Company on behalf of Wilsey. Included in accounts payable at March 31, 2002 and 2001 were $5,976,000 and $3,347,000, respectively, payable to Cenex for purchases of oil. Purchases from Cenex for the year ended March 31, 2002 and for the three months ended March 31, 2001 and the years ended December 31, 2000 and 1999 were $47,745,000, $8,575,000, $48,916,000, and $84,872,000, respectively. Sales to Cenex for the year ended March 31, 2002 and for the three months ended March 31, 2001 and the years ended December 31, 2000 and 1999, totaled $883,000, $109,000, $950,000, and $1,130,000, respectively. Included in accounts payable at March 31, 2002 and 2001 were $817,000 and $448,000, respectively, payable to Mitsui USA for the Company's participation in Mitsui USA's insurance plans. During the year ended March 31, 2001 and the three months ended March 31, 2001 and the years ended December 31, 2000 and 1999, the Company recorded expenses of $8,487,000, $1,380,000, $5,049,000, and $5,677,000, respectively, in connection with its participation in such plans. Included in trade receivables at March 31, 2002 and 2001 were $69,000 and $110,000, respectively, of receivables from Mitsui USA for product sales. Sales to Mitsui USA for the year ended March 31, 2002 and the three months ended March 31, 2001 and the years ended December 31, 2000 and 1999, totaled $1,406,000, $341,000, $1,569,000, and $2,509,000, respectively. Forward purchase contracts as of March 31, 2002 included commitments for purchases of 78,653,000 pounds of oil from Cenex. The Company recognized gains (losses) of $934,000, $1,788,000, $(363,000), and $(25,000), respectively, on such related party commitments for the year ended March 31, 2002 and for the three months ended March 31, 2001 and the years ended December 31, 2000 and 1999. 6. EMPLOYEE BENEFIT PLANS The Company had long-term incentive arrangements for certain key executives. Benefits under the arrangements were based on earnings over a three-to five-year period (as defined) from inception of the arrangements (January 1, 1997) through December 31, 2001. The incentive period ended on December 31, 2001. An amount equal to the obligation incurred under the plan was contributed to a rabbi trust that would be available to general creditors in the event of bankruptcy. The trust holds investments primarily in marketable securities that are recorded at market value (classified as trading securities). The assets in the trust are to be distributed to the employees upon retirement. The liability under the arrangements was $14,240,000 and $8,774,000 as of March 31, 2002 and 2001, respectively, and is included in accrued compensation in the accompanying consolidated balance sheets. On January 1, 2002, the Company established new long-term incentive arrangements with certain key executives under which they can earn additional compensation. Under these arrangements, the amount of additional compensation is based on the attainment of cumulative income-based or equity-based targets over a two-to three-year period. At the end of such periods, amounts earned by individual executives will be contributed to a rabbi trust, unless representatives of Wilsey and Cenex elect to pay such amounts directly to the respective key executives. At March 31, 2002, a liability for such awards of $439,000 is classified as accrued compensation in the accompanying consolidated balance sheets. For the year ended March 31, 2002 and the three months ended March 31, 2001 and the years ended December 31, 2000 and 1999, the Company recognized compensation expense under the long-term incentive arrangements of $5,657,544, $749,815, $5,883,929, and $1,780,445, respectively. F-38 VENTURA FOODS, LLC AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) YEAR ENDED MARCH 31, 2002 AND THE THREE MONTHS ENDED MARCH 31, 2001 AND THE YEARS ENDED DECEMBER 31, 2000 AND 1999 6. EMPLOYEE BENEFIT PLANS (CONTINUED) The Company has a combined 401(k) and defined contribution profit-sharing plan (the "Plan") covering substantially all employees not covered by collective bargaining agreements. Under the Plan, employees can make annual voluntary contributions not to exceed the lesser of an amount equal to 15 percent of their compensation or limits established by the Internal Revenue Code. The Company is required by the Plan to make certain matching contributions of up to 4 percent of each participant's salary and may make discretionary profit-sharing contributions. The Company also established a 401(k) defined contribution plan covering employees under certain collective bargaining agreements. Under this plan, employees can make annual voluntary contributions of up to 15 percent of their compensation. Expense for the years ended March 31, 2002 and the three months ended March 31, 2001 and the years ended December 31, 2000 and 1999 was $5,855,000, $1,343,000, $5,139,000, and $5,212,000, respectively. Certain of the Company's union employees are participants in multi-employer plans. Payments to multi-employer pension plans are negotiated in various collective bargaining agreements and aggregated $1,162,000, $416,000, $1,641,000, and $1,465,000, for the year ended March 31, 2002 and for the three months ended March 31, 2001 and the years ended December 31, 2000 and 1999, respectively. The actuarial present value of accumulated plan benefits and net assets available for benefits to union employees under these multi-employer pension plans are not available, as the Company does not administer these plans. Effective January 1, 1999, the Company established a Supplemental Executive Retirement Plan for certain of its employees. The projected benefit obligation as of March 31, 2002 and 2001 was $2,049,000 and $1,484,000, respectively. A liability of $1,668,000 and $1,557,000, as of March 31, 2002 and 2001, respectively, is included in long-term accrued compensation in the accompanying consolidated balance sheets. The plan is unfunded. During the year ended March 31, 2002 and the three months ended March 31, 2001 and the years ended December 31, 2000 and 1999, the Company recorded benefit expense related to the plan of $111,000, $420,000, $379,000, and $412,000, respectively. The assumptions used in the measurement of the Company's benefit obligation are as follows:
MARCH 31, DECEMBER 31, --------------------- --------------------- 2002 2001 2000 1999 --------- --------- --------- --------- Discount rate ......................... 7.0% 7.0% 7.0% 7.5% Rate of compensation increase ......... 3.0% 3.0% 3.0% 4.0%
The Company accrues the actuarially determined amount necessary to fund the participants' benefits in accordance with the requirements of the Employee Retirement Income Security Act of 1974. 7. COMMITMENTS AND CONTINGENCIES Future minimum annual payments under noncancelable operating leases with lease terms in excess of one year at March 31, 2002 are as follows: 2003 ................. $ 4,960,000 2004 ................. 3,881,000 2005 ................. 3,092,000 2006 ................. 1,826,000 2007 ................. 669,000 Thereafter ........... 203,000 ------------ Total ................ $ 14,631,000 ============ Under the lease agreements, the Company is obligated to pay certain property taxes, insurance, and maintenance costs. Certain leases contain renewal and purchase options. Rental expense for the year F-39 VENTURA FOODS, LLC AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) YEAR ENDED MARCH 31, 2002 AND THE THREE MONTHS ENDED MARCH 31, 2001 AND THE YEARS ENDED DECEMBER 31, 2000 AND 1999 7. COMMITMENTS AND CONTINGENCIES (CONTINUED) ended March 31, 2002 and for the three months ended March 31, 2001 and the years ended December 31, 2000 and 1999 under operating leases totaled $5,671,000, $1,476,000, $5,205,000, and $5,121,000, respectively. During the year ended December 31, 2000, the Company received a payment of approximately $2.4 million in connection with the settlement of a class action lawsuit. This amount has been recorded as a component of other income in the accompanying consolidated statements of income. The Company is involved from time to time in routine legal matters incidental to its business. The Company believes that the resolution of such matters will not have a material adverse effect on the Company's business, financial condition, or results of operations. 8. QUARTERLY INFORMATION (UNAUDITED) As discussed in Note 2, the Company changed its fiscal year-end to March 31. Audited financial information for the three months ended March 31, 2001 has been included herein. For comparison purposes, selected unaudited financial information for the three months ended March 31, 2000 is as follows: Sales ........................ $211,815,000 Cost of goods sold ........... 172,818,000 Net income ................... 17,123,000 Total assets ................. 362,382,000 Total liabilities ............ 231,789,000 Members' capital ............. 130,593,000 F-40