UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q (Mark One) { X } QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended October 1, 2005 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 1-3390 Seaboard Corporation (Exact name of registrant as specified in its charter) Delaware 04-2260388 (State or other jurisdiction of (I.R.S. Employer Identification No.) incorporation or organization) 9000 W. 67th Street, Shawnee Mission, Kansas 66202 (Address of principal executive offices) (Zip Code) (913) 676-8800 (Registrant's telephone number, including area code) Not Applicable (Former name, former address and former fiscal year, if changed since last report.) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X . No . Indicate by a check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes X . No . Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes . No X . There were 1,255,053.90 shares of common stock, $1.00 par value per share, outstanding on October 24, 2005. Total pages in filing - 24 pages
1 PART I - FINANCIAL INFORMATION Item1. Financial Statements SEABOARD CORPORATION AND SUBSIDIARIES Condensed Consolidated Balance Sheets (Thousands of dollars) (Unaudited) October 1, December 31, 2005 2004 Assets Current assets: Cash and cash equivalents $ 50,084 $ 14,620 Short-term investments 247,189 119,259 Receivables, net 222,775 246,129 Inventories 313,688 301,049 Deferred income taxes 16,137 14,341 Other current assets 48,884 48,040 Total current assets 898,757 743,438 Investments in and advances to foreign affiliates 37,035 38,001 Net property, plant and equipment 625,684 603,382 Goodwill 28,261 - Intangible assets, net 30,460 - Other assets 38,711 51,873 Total assets $1,658,908 $1,436,694 Liabilities and Stockholders' Equity Current liabilities: Notes payable to banks $ 1,983 $ 1,789 Current maturities of long-term debt 61,166 60,756 Accounts payable 103,037 83,506 Other current liabilities 155,675 162,855 Total current liabilities 321,861 308,906 Long-term debt, less current maturities 223,963 262,544 Deferred income taxes 125,979 125,559 Other liabilities 55,272 44,865 Total non-current and deferred liabilities 405,214 432,968 Minority and other noncontrolling interests 48,252 2,138 Stockholders' equity: Common stock of $1 par value, Authorized 4,000,000 shares; issued and outstanding 1,255,054 shares 1,255 1,255 Additional paid-in capital 8,317 - Accumulated other comprehensive loss (52,186) (53,741) Retained earnings 926,195 745,168 Total stockholders' equity 883,581 692,682 Total liabilities and stockholders' equity $1,658,908 $1,436,694 See notes to condensed consolidated financial statements.
2 SEABOARD CORPORATION AND SUBSIDIARIES Condensed Consolidated Statements of Earnings (Thousands of dollars except per share amounts) (Unaudited) Three Months Ended Nine Months Ended October 1, October 2, October 1, October 2, 2005 2004 2005 2004 Net sales: Products $ 451,247 $ 522,422 $1,542,199 $1,563,177 Services 164,387 132,272 488,143 388,375 Other 21,145 12,768 56,726 43,892 Total net sales 636,779 667,462 2,087,068 1,995,444 Cost of sales and operating expenses: Products 384,128 454,546 1,313,989 1,398,154 Services 133,414 101,466 381,486 301,871 Other 17,831 10,516 47,126 33,773 Total cost of sales and operating expenses 535,373 566,528 1,742,601 1,733,798 Gross income 101,406 100,934 344,467 261,646 Selling, general and administrative expenses 36,023 29,566 99,856 91,989 Operating income 65,383 71,368 244,611 169,657 Other income (expense): Interest expense (5,206) (6,120) (16,810) (20,538) Interest income 3,729 2,140 9,985 5,705 Income (loss) from foreign affiliates 235 103 (1,509) (128) Minority and other noncontrolling interests (2,118) (227) (2,590) (621) Foreign currency gain (loss), net (439) 5,040 (380) 3,536 Loss from the sale of a portion of operations 27 - (1,746) - Miscellaneous, net 4,385 (5,161) 4,691 (2,288) Total other income (expense), net 613 (4,225) (8,359) (14,334) Earnings before income taxes 65,996 67,143 236,252 155,323 Income tax expense (13,406) (20,595) (52,401) (47,142) Net earnings $ 52,590 $ 46,548 $ 183,851 $ 108,181 Earnings per common share Basic $ 41.90 $ 37.09 $ 146.49 $ 86.20 Diluted $ 41.69 $ 37.09 $ 146.24 $ 86.20 Weighted average shares outstanding Basic 1,255,123 1,255,054 1,255,077 1,255,054 Diluted 1,261,367 1,255,054 1,257,151 1,255,054 Dividends declared per common share $ 0.75 $ 0.75 $ 2.25 $ 2.25 See notes to condensed consolidated financial statements.
3 SEABOARD CORPORATION AND SUBSIDIARIES Condensed Consolidated Statements of Cash Flows (Thousands of dollars) (Unaudited) Nine Months Ended October 1, October 2, 2005 2004 Cash flows from operating activities: Net earnings $ 183,851 $ 108,181 Adjustments to reconcile net earnings to cash from operating activities: Depreciation and amortization 47,859 48,590 Loss from foreign affiliates 1,509 128 Foreign currency exchange gains (31) (246) Loss from the sale of a portion of operations 1,746 - Deferred income taxes (1,709) 35,613 Changes in current assets and liabilities, net of portion of operations sold and business acquired: Receivables, net of allowance 37,246 (84,497) Inventories (28,184) (17,983) Other current assets (3,745) (10,632) Current liabilities exclusive of debt 19,956 24,089 Other, net 5,487 (63) Net cash from operating activities 263,985 103,180 Cash flows from investing activities: Purchase of short-term investments (488,938) (144,874) Proceeds from the sale or maturity of short-term investments 361,008 138,592 Investments in and advances to foreign affiliates, net 245 3,014 Proceeds from the sale of a portion of operations 25,821 - Acquisition of business (47,540) - Capital expenditures (43,208) (21,768) Other, net 5,988 4,089 Net cash from investing activities (186,624) (20,947) Cash flows from financing activities: Notes payable to banks, net 194 (64,212) Principal payments of long-term debt (37,937) (32,297) Repurchase of minority interest in a controlled subsidiary (485) (5,000) Dividends paid (2,824) (2,824) Other, net (1,187) 1,048 Net cash from financing activities (42,239) (103,285) Effect of exchange rate change on cash 342 1,957 Net change in cash and cash equivalents 35,464 (19,095) Cash and cash equivalents at beginning of year 14,620 37,377 Cash and cash equivalents at end of period $ 50,084 $ 18,282 See notes to condensed consolidated financial statements.
4 SEABOARD CORPORATION AND SUBSIDIARIES Notes to Condensed Consolidated Financial Statements (Unaudited) Note 1 - Accounting Policies and Basis of Presentation The condensed consolidated financial statements include the accounts of Seaboard Corporation and its domestic and foreign subsidiaries ("Seaboard"). All significant intercompany balances and transactions have been eliminated in consolidation. Seaboard's investments in non- controlled affiliates are accounted for by the equity method. The unaudited condensed consolidated financial statements should be read in conjunction with the consolidated financial statements of Seaboard for the year ended December 31, 2004 as filed in its Annual Report on Form 10-K. Seaboard's first three quarterly periods include approximately 13 weekly periods ending on the Saturday closest to the end of March, June and September. Seaboard's year-end is December 31. The accompanying unaudited condensed consolidated financial statements include all adjustments (consisting only of normal recurring accruals) which, in the opinion of management, are necessary for a fair presentation of financial position, results of operations and cash flows. Results of operations for interim periods are not necessarily indicative of results to be expected for a full year. Use of Estimates The preparation of the consolidated financial statements in conformity with U.S. generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the consolidated financial statements, and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Derivative Instruments As of January 1, 2005, Seaboard discontinued accounting for its foreign currency exchange agreements as hedges for all new agreements entered into by the commodity trading business. In addition, as of January 1, 2005, Seaboard de-designated all then outstanding hedges with a value of $5,558,000, effectively fixing the asset resulting from the mark-to-market gain on the firm sales commitment recorded in other current assets on the Consolidated Balance Sheets as of December 31, 2004, until such time as the firm sales commitments mature. Beginning January 1, 2005, the mark-to-market changes in the foreign exchange agreements were no longer offset with the mark-to-market changes of the underlying firm sales commitment. While $50,000 and $4,241,000 of the related sales were consummated during the three and nine months ended October 1, 2005, respectively, $1,317,000 of the firm sales commitments were also sold as part of the sale of a portion of the third party trading operations as discussed in Note 2. There was no remaining net asset value as of October 1, 2005. Although management believes all of these instruments effectively managed market risks, the growth of Seaboard's commodity trading business increased the ongoing costs to maintain the extensive record-keeping requirements to qualify these instruments as hedges for accounting purposes. Seaboard's interest rate exchange agreements do not qualify as hedges for accounting purposes. During the three and nine months ended October 1, 2005 Seaboard recorded gains of $3,101,000 and $1,713,000, respectively, related to these agreements compared to losses of $4,172,000 and $4,016,000 during the same periods of 2004. The gains and losses are included in miscellaneous, net on the Condensed Consolidated Statements of Earnings and reflect changes in fair market value, net of interest paid or received. During the 2005 three and nine month periods, Seaboard made net payments of $1,162,000 and $3,585,000 respectively, compared to payments made of $2,142,000 and $5,409,000 during the same periods of 2004 resulting from the difference between the fixed rate paid and variable rate received on these agreements. The nature of Seaboard's market risk exposure related to its derivative instruments has not changed materially since December 31, 2004 although the amount of commodity futures and option contracts and foreign exchange contracts decreased considerably with the sale of a portion of the third party trading operations as discussed in Note 2.
5 Supplemental Non-Cash Transactions As more fully described in Note 2, Seaboard sold some components of its third party commodity trading operations in May 2005. The following table summarizes the non-cash transactions resulting from this sale: Nine Months Ended (Thousands of dollars) October 1, 2005 Decrease in net working capital $28,053 Decrease in fixed assets 75 Decrease in other assets 88 Receivable from buyer as of October 1, 2005 (649) Loss on the sale of a portion of operations (1,746) Net proceeds from sale $25,821 As more fully described in Note 2, Seaboard acquired a bacon processor in July 2005. The following table summarizes the non-cash transactions resulting from this acquisition: Nine Months Ended (Thousands of dollars) October 1, 2005 Increase in net working capital $11,600 Increase in fixed assets 28,800 Increase in intangible assets 30,800 Increase in goodwill 28,300 Increase in non-controlling interest (44,500) Increase in other non-controlling interest (200) Increase in put option value (6,700) Payable to seller as of October 1, 2005 (600) Cash paid $47,500 Asset Retirement Obligations Seaboard has recorded a long-lived asset and related liability for asset retirement obligation costs associated with the closure of the hog lagoons it is legally obligated to close. The following table shows the changes in the asset retirement obligation during the three and nine month periods of each year. Three Months Ended Nine Months Ended October 1, October 2, October 1, October 2, (Thousands of dollars) 2005 2004 2005 2004 Beginning balance $6,498 $6,449 $6,266 $6,086 Accretion expense 116 116 348 345 Liability for additional lagoons placed in service - - - 134 Ending balance $6,614 $6,565 $6,614 $6,565 New Accounting Standards On December 21, 2004, the FASB issued FASB Staff Position 109-2, "Accounting and Disclosure Guidance for the Foreign Earnings Repatriation Provision within the American Jobs Creation Act of 2004" (FSP 109-2). FSP 109-2, which was effective upon issuance, allows companies time beyond the financial reporting period of enactment to evaluate the effect of the earnings repatriation provision on its plan for reinvestment or repatriation of foreign earnings for purposes of applying SFAS 109. Additionally, FSP 109-2 provides guidance regarding the required disclosures surrounding a company's reinvestment or repatriation of foreign earnings. See Note 4 for further discussion.
6 Note 2 - Acquisitions, Dispositions and Repurchase of Minority Interest On July 5, 2005, Seaboard completed the acquisition effective July 3, 2005 of Daily's, a bacon processor located in the western United States, for approximately $44,500,000 in cash, plus preliminary working capital adjustments of approximately $3,100,000 subject to final adjustments, a 4.74% equity interest in Seaboard Foods LLC (previously Seaboard Farms, Inc.) with an estimated value of approximately $44,500,000, a put option associated with the 4.74% equity interest estimated to have a fair value of approximately $6,700,000, as discussed below and $700,000 of additional acquisition costs incurred. The acquisition includes Daily's two bacon processing plants located in Salt Lake City, Utah and Missoula, Montana. Daily's produces premium sliced and pre-cooked bacon primarily for food service. This acquisition continues Seaboard's expansion of its integrated pork model into value-added products and is expected to enhance Seaboard's ability to venture into other further processed pork products. The Sellers have an option to put their 4.74% equity interest back to Seaboard after two years for the greater of $40 million or a formula determined value, as defined, as of the put date. The minimum put option value of $40 million expires after five years. Likewise, Seaboard has a call provision after five years of operations whereby Seaboard could reacquire the 4.74% equity interest for the greater of $45 million or a formula determined value. The percentage ownership interest issued to the Sellers was based on an earnings multiple of the business which approximates fair value. Seaboard is in the process of finalizing the agreement of working capital acquired and finalizing third-party valuations of the real estate and certain intangible assets acquired; accordingly the purchase price allocation may be revised when final information is obtained and completed. The following table summarizes the preliminary allocation of the purchase price to the fair values of the assets acquired and liabilities assumed at the effective acquisition date of July 3, 2005. (Thousands of dollars) July 3, 2005 Net working capital $11,600,000 Net property, plant and equipment 28,800,000 Intangible assets 30,800,000 Goodwill 28,300,000 Purchase price, subject to final adjustments $99,500,000 The intangible assets acquired include approximately $24,000,000 of trade names and registered trademarks which are not subject to amortization. The remaining intangible asset balance consists primarily of contractual and direct customer relationships, and covenants not to compete and will be amortized over five years. Operating results for Daily's are included in Seaboard's Consolidated Statement of Operations from the date of acquisition. Pro forma results of operations are not presented, as the effects of the acquisition are not considered material to Seaboard's results of operations. Effective May 9, 2005 Seaboard's Commodity Trading and Milling segment agreed to sell some components of its third party commodity trading operations, consisting primarily of certain forward sales contracts, certain grain inventory and all related contracts to support such sales contracts, including commodity futures and options, foreign exchange agreements, purchase contracts and charter agreements for $26,470,000, subject to final adjustments. This transaction closed on May 27, 2005. As a result of the sale, Seaboard intends to focus on the supply of raw materials to its core milling operations and the transaction of third party commodity trades in support of these operations. In addition, Seaboard intends to continue competing in many of the markets and routes associated with the sale transaction, although at a reduced level. The counterparty to this transaction is a South African multi-national shipping company, Grindrod Limited. Since Seaboard does not use hedge accounting for its commodity and foreign exchange derivative instruments, these derivative instruments were marked to market through the effective date of the sale while the change in value of the related commodity forward purchase and sale agreements were not. As a result, derivative gains relating to derivative instruments sold totaling $2,161,000 were included in operating income prior to the sale of a portion of the operations resulting in a loss on the sale transaction totaling $1,746,000, subject to final adjustments.
7 Since Seaboard has conducted its commodity trading business with third parties, consolidated subsidiaries, and foreign affiliates on an interrelated basis and intends to continue trading with third parties in certain markets, operating income from the business sold cannot be clearly distinguished from the remaining operations of Seaboard's Commodity Trading and Milling segment without making numerous subjective assumptions primarily with respect to mark-to-market accounting. For the first half of 2005, this transaction did not have a material effect on net sales, net earnings or earnings per common share as transactions in process at the date of sale were completed by and the responsibility of Seaboard after the date of sale. Seaboard's revenues from the portion of the operations sold for the first two quarters of 2005 totaled approximately $317,291,000, compared to $311,952,000 for the first two quarters of 2004. Net sales for the third quarter of 2005 for third party commodity trading operations decreased $98,845,000, compared to the same period in 2004, primarily as a result of the sale to Grindrod Limited and will continue to be comparably smaller than 2004 for the remainder of 2005 primarily as a result of this transaction; however, the extent of the decrease beyond 2005 will depend on Seaboard's ability to effectively compete in the markets. In connection with the December 2001 sale of a 10% minority interest in one of the two power barges in the Dominican Republic, the buyer was given a three-year option to sell the interest back to Seaboard for the book value at the time of sale, pending collections of outstanding receivables. During January 2004, the buyer provided notice to exercise the option valued at $5,709,000. An initial payment of $5,000,000 was paid during the second quarter of 2004 to reacquire this interest and $485,000 was paid during the third quarter of 2005 with the remaining balance payable upon collection of the remaining outstanding receivables. In addition, Seaboard has historically paid commissions to a related entity of the above party relative to the performance of the other power barge. During the second quarter of 2004 Seaboard agreed to terminate that relationship by making a one-time payment of $2,000,000, included in selling, general and administrative expenses. Note 3 - Inventories The following is a summary of inventories at October 1, 2005 and December 31, 2004: October 1, December 31, (Thousands of dollars) 2005 2004 At lower of LIFO cost or market: Live hogs & materials $145,213 $141,126 Dressed pork & materials 20,809 20,334 166,022 161,460 LIFO allowance 3,389 461 Total inventories at lower of LIFO cost or market 169,411 161,921 At lower of FIFO cost or market: Grain, flour and feed 91,802 98,699 Sugar produced & in process 20,526 20,006 Other 31,949 20,423 Total inventories at lower of FIFO cost or market 144,277 139,128 Total inventories $313,688 $301,049 Note 4 - Income Taxes During the fourth quarter of 2004, President Bush signed into law H.R. 4520, the American Jobs Creation Act ("Act"). The Act is a significant and complicated reform of U.S. income tax law. The Act contains several provisions which will be favorable for Seaboard. Of particular note, the Act repealed the prior law treatment of shipping income as a component of subpart F income. This change allows Seaboard to avoid current U.S. taxation on its post-2004 shipping income and has a material impact on Seaboard's 2005 and future effective tax rate and cash tax payments. This change decreased income tax expense approximately $5,580,000 and $19,234,000 for the three and nine months ended October 1, 2005, respectively. The Act would also allow Seaboard a one-time election to repatriate permanently invested foreign earnings at a 5.25% effective U.S. income tax rate rather than the statutory 35% rate, if certain domestic reinvestment requirements are met. Management is currently evaluating this provision of the Act and expects to complete its evaluation in the fourth quarter of 2005. Factors in Seaboard's decision to utilize this provision include its ability to economically borrow at the foreign subsidiary level to allow for the payment of a qualifying dividend, the recent
8 disposition of a portion of the third party commodity trading operations discussed in Note 2 above, and Seaboard's planned domestic and international cash needs. Because of various uncertainties, the range of potential dividend amounts and corresponding taxes cannot be reasonably estimated at this time. As of October 1, 2005, no provision has been made in the accounts for Federal income taxes which would be payable if the undistributed earnings of certain foreign subsidiaries were distributed to Seaboard Corporation since management has currently determined that the earnings are permanently invested in these foreign operations. Should such accumulated earnings be distributed, ignoring the one-time election to repatriate foreign earnings at a reduced rate, the resulting Federal income taxes applicable to earnings through October 1, 2005 assuming a 35% federal income tax rate would have amounted to approximately $105,000,000. Seaboard is regularly audited by federal, state and foreign tax authorities, which may result in adjustments. The IRS has recently closed its examination of Seaboard's federal income tax returns for 2000 through 2002 and as part of its normal process forwarded the case for review to the Joint Committee on Taxation (JCT). If the IRS report is accepted by the JCT, Seaboard will record a tax benefit when the case is finalized. Seaboard also filed tax returns utilizing NOLs on September 15, 2005. See Note 7 for further discussion. Note 5 - Employee Benefits Seaboard maintains a defined benefit pension plan (the Plan) for its domestic salaried and clerical employees. While Seaboard's policy has historically been to provide funding to the Plan in order to meet the minimum funding standards to avoid the Pension Benefit Guaranty Corporation variable rate premiums established by the Employee Retirement Income Security Act of 1974, Seaboard made a special contribution equal to the maximum deductible amount in the fourth quarter of 2004 resulting in an over-funding of the Plan. As a result, management does not expect to make any contributions to the Plan during 2005. Additionally, Seaboard also sponsors non-qualified, unfunded supplemental executive plans, and unfunded supplemental retirement agreements with certain executive employees. Management currently has no plans to provide funding for these supplemental plans. The net periodic benefit cost of these plans was as follows: Three months ended Nine months ended October 1, October 2, October 1, October 2, (Thousands of dollars) 2005 2004 2005 2004 Components of net periodic benefit cost: Service cost $ 924 $ 854 $ 2,782 $ 2,467 Interest cost 1,096 1,021 3,300 2,877 Expected return on plan assets (1,123) (847) (3,387) (2,414) Amortization and other 294 210 884 605 Net periodic benefit cost $ 1,191 $1,238 $ 3,579 $ 3,535 Note 6 - Commitments and Contingencies Seaboard reached an agreement in 2002 to settle litigation brought by the Sierra Club. Under the terms of the settlement, Seaboard conducted an investigation at three farms. Based on the investigation, it has been determined that two farms do not require any corrective action. The investigation at the one remaining farm is continuing; however, it has been determined that the lagoon at this farm is a likely source of elevated nitrates in the ground water. Seaboard advised the Oklahoma Department of Agriculture, Food & Forestry as to this fact, and is in the process of determining the necessary corrective action. The cost of the repairs and any other implications are not known at this time, but if a new lagoon is constructed, the cost could exceed $1 million. The farm was one of the farms purchased from PIC International Group, Inc. (PIC). Seaboard has given notice to PIC as to its right to indemnification from any loss as a result of the lagoon. To date, PIC has declined to provide indemnification.
9 Seaboard is subject to regulatory actions and an investigation by the United States Environmental Protection Agency (EPA) and the State of Oklahoma. One such action involves five properties utilized in Seaboard's hog production operations which were purchased from PIC International Group, Inc. (PIC). Seaboard has undertaken an extensive investigation, and has had significant discussions with the EPA and the State of Oklahoma, proposing to undertake continued monitoring and take a number of corrective actions with respect to the farms, and one additional farm, in order to attempt to settle the action. The EPA, Seaboard and PIC have also engaged in settlement negotiations regarding civil penalty. Originally, the EPA stated that any settlement must include a civil fine of $1,200,000, but the EPA has since reduced the amount of its demand for a civil penalty to $345,000. Seaboard believes that the EPA has no authority to impose a civil fine, but settlement discussions are continuing. If the matter is not settled, the EPA could bring an action against Seaboard, although Seaboard believes it has meritorious defenses to any such action. The EPA could instead determine to take no further action. A tentative verbal settlement has been reached with the State of Oklahoma to resolve the State's notice of violation regarding the same farms and allegations of violations of State law based on the same facts as those alleged by the EPA. The settlement with the State of Oklahoma would require Seaboard to pay a fine of $100,000 and to undertake agreed upon supplemental environmental projects at a cost of approximately $80,000. The settlement is subject to the final terms of the settlement being agreed to and the approval of the Oklahoma Board of Agriculture. Irrespective of the settlement, Seaboard has completed or is in the process of completing many of the proposed corrective actions at the relevant farms. PIC is indemnifying Seaboard with respect to the action pursuant to an indemnification agreement which has a $5 million limit. To date, the $5 million limit has not been exceeded. If the tentative settlement with the State of Oklahoma is agreed to, the estimated cumulative costs which will be expended will total approximately $6.9 million, not including the additional legal costs required to negotiate the settlement or the penalties demanded by the EPA and tentatively agreed to with the State of Oklahoma. If the measures taken pursuant to the settlement are not effective, other measures with additional costs may be required. PIC has advised Seaboard that it is not responsible for the costs in excess of $5 million. Seaboard disputes PIC's determination of the costs to be included in the calculation to determine whether the $5 million limit will be exceeded and believes that the costs to be considered are less than $5 million, such that PIC is responsible for all such costs and penalties, except for approximately $180,000 of estimated costs that would be incurred over 5 years subsequent to the settlement for certain testing and sampling. Seaboard has agreed to conduct such testing and sampling as a part of the sampling it conducts in the normal course of operations and believes that the incremental costs incurred to conduct such testing and sampling will be less than $180,000. Seaboard also believes that a more general indemnity agreement would require indemnification of liability in excess of $5 million (excluding the estimated $180,000 cost for testing and sampling), although PIC disputes this. Seaboard is subject to various other legal proceedings related to the normal conduct of its business, including various environmental related actions. In the opinion of management, none of these actions is expected to result in a judgment having a materially adverse effect on the consolidated financial statements. From time to time bills have been introduced in the United States Senate and House of Representatives which included provisions to prohibit meat packers, such as Seaboard, from owning or controlling livestock intended for slaughter. Such bills could have prohibited Seaboard from owning or controlling hogs, and thus would have required divestiture of our operations, or otherwise a restructuring of the ownership and operation. In April of 2005, such a bill was again introduced in the Senate, although Seaboard does not expect any such action to be passed in 2005. Contingent Obligations Certain of the non-consolidated affiliates and third party contractors who perform services for Seaboard have bank debt supporting their underlying operations. From time to time, Seaboard will provide guarantees of that debt allowing a lower borrowing rate or facilitating third party financing in order to further Seaboard's business objectives. Seaboard does not issue guarantees of third parties for compensation. The following table sets forth the terms of guarantees as of October 1, 2005. Guarantee beneficiary Maximum exposure Maturity Foreign non-consolidated affiliate grain $ 712,000 Annual renewal processor - Uganda Foreign non-consolidated affiliate food $ 400,000 August 2006 product distributor - Ecuador Various hog contract growers $1,529,000 Annual renewal
10 Seaboard guaranteed a bank borrowing for a subsidiary of a foreign affiliate grain processor in Kenya, Unga Holdings Limited (Unga), a nonconsolidated milling affiliate, to facilitate bank financing used for the rehabilitation and expansion of a milling facility in Uganda. This guarantee was a part of the original purchase agreement with Unga when Seaboard first invested in this company in 2000. The guarantee can be drawn upon in the event of non-payment of a bank borrowing by Unga. While the guarantee may be cancelled by Seaboard annually, the bank has the right to draw on the guarantee in the event it is advised that the guarantee will be cancelled. The guarantee renews annually until the debt expires in 2007. Unga Holdings has provided a reciprocal guarantee to Seaboard. As of October 1, 2005, $616,000 was outstanding related to this guarantee. The non-consolidated affiliate food product distributor in Ecuador purchases certain products from a U.S. domiciled vendor. Seaboard has guaranteed the payments for these purchases in order to secure normal credit terms for this affiliate. Seaboard has guaranteed a portion of the bank debt for certain farmers, which debt proceeds were used to construct facilities to raise hogs for Seaboard's Pork segment. The guarantees enabled the farmers to obtain favorable financing terms. These bank guarantees renew annually until the underlying debt is fully repaid in 2013-2014. The maximum exposure to Seaboard from these guarantees is $1,529,000. Seaboard has not accrued a liability for any of the third party or affiliate guarantees as management considered the likelihood of loss to be remote. As of October 1, 2005, Seaboard had outstanding $52,900,000 of letters of credit (LCs) with various banks that reduced Seaboard's borrowing capacity under its committed credit facility. Included in this amount are LCs totaling $42,688,000 which support the Industrial Development Revenue Bonds included as long-term debt and $9,458,000 of LCs related to insurances coverages. Note 7 - Stockholders' Equity and Accumulated Other Comprehensive Income (Loss) In conjunction with a 2002 transaction (the Transaction) between Seaboard and its parent company, Seaboard Flour LLC (the Parent Company), whereby Seaboard effectively repurchased shares of its common stock owned by the Parent Company in return for repayment of all indebtedness owed by the Parent Company to Seaboard, the Parent Company also transferred to Seaboard rights to receive possible future cash payments from a subsidiary of the Parent Company and the benefit of other assets owned by that subsidiary. Seaboard also received tax net operating losses ("NOLs") which allow Seaboard to reduce the amount of future income taxes it otherwise would pay. To the extent Seaboard receives cash payments as a result of the transferred rights or reduces its federal income taxes payable by utilizing the NOLs, Seaboard agreed to issue to the Parent Company new shares of common stock with a value equal to the cash received and/or the NOLs utilized. The value of the common stock for purposes of determining the number of shares issued is equal to the ten day rolling average closing price, determined as of the twentieth day prior to the issue date. The maximum number of shares of common stock which may be issued to the Parent Company under the Transaction is capped at 232,414.85, the number of shares which were originally purchased from the Parent Company. On September 15, 2005, Seaboard filed tax returns utilizing the NOLs resulting in reducing its federal income tax by $8,317,416. Based on terms of the Transaction, the price of the shares of Seaboard's common stock to be issued to the Parent Company is equal to the ten day rolling average closing price prior to October 1, 2005, which was $1,317.44. This resulted in Seaboard issuing 6,313.34 shares to Parent Company on November 3, 2005. As of October 1, 2005, Seaboard has accounted for this income tax benefit by reducing current taxes payable in the amount of $8,317,416 and recording additional paid in capital. As all contingencies regarding the issuance of the shares to the Parent Company were resolved as of October 1, 2005, the weighted average number of shares presented below reflect such shares as outstanding for one day for the basic earnings per share periods and for the entire third quarter for the diluted earnings per share periods. The following table reconciles the number of shares utilized in the earnings per share calculations: Three Months Ended Nine Months Ended October 1, October 2, October 1, October 2, 2005 2004 2005 2004 Weighted average number of shares Common shares - basic 1,255,123 1,255,054 1,255,077 1,255,054 Effect of dilutive securities Stock issuance to Parent 6,244 - 2,074 - Common shares - diluted 1,261,367 1,255,054 1,257,151 1,255,054
11 Components of total comprehensive income, net of related taxes, are summarized as follows: Three Months Ended Nine Months Ended October 1, October 2, October 1, October 2, (Thousands of dollars) 2005 2004 2005 2004 Net earnings $52,590 $46,548 $183,851 $108,181 Other comprehensive income (loss) net of applicable taxes: Foreign currency translation adjustment (993) (470) 1,441 1,457 Unrealized gains on investments 62 37 109 111 Unrealized gains on cash flow hedges - 80 155 18 Amortization of deferred gain on interest rate swaps (50) (50) (150) (150) Total comprehensive income $51,609 $46,145 $185,406 $109,617 The components of and changes in accumulated other comprehensive loss for the nine months ended October 1, 2005 are as follows: Balance Balance December 31, Period October 1, (Thousands of dollars) 2004 Change 2005 Foreign currency translation adjustment $(53,986) $1,441 $(52,545) Unrealized gain on investments 257 109 366 Unrecognized pension cost (375) - (375) Net unrealized loss on cash flow hedges (188) 155 (33) Deferred gain on interest rate swaps 551 (150) 401 Accumulated other comprehensive loss $(53,741) $1,555 $(52,186) The unrecognized pension cost is calculated and adjusted annually during the fourth quarter. With the exception of the foreign currency translation loss to which a 35% federal tax rate is applied, income taxes for components of accumulated other comprehensive loss were recorded using a 39% effective tax rate. Note 8 - Segment Information As a result of sustained losses from an investment in a Bulgarian wine business (the Business) and recognition in 2004 of a decline in value considered other than temporary, Seaboard's common stock investment and subordinated debt in the Business were reduced to zero. During 2005, Seaboard began applying losses from the Business against its remaining investment in preferred stock, based on the change in Seaboard's claim on the Business' book value. As a result, Seaboard increased its share of losses to 100%. In February 2005, the Board of Directors of the Business, and the majority of the owners of the Business, including Seaboard, agreed to pursue the sale of the entire Business or all of its assets. During the third quarter of 2005, certain equity holders agreed to advance up to 4.5 million Euros (approximately $5.4 million) to the Business, one- half by Seaboard, to fulfill the terms of its debt covenants, make principal payments, avoid bankruptcy and finance the current year's grape purchases. As of October 1, 2005, Seaboard had advanced $1,751,000. Based on current negotiations to sell a substantial portion of the Business and all related wine labels, and other information on the fair value for the sale of all other assets of this Business, management believes if negotiations are successful the remaining carrying value of its investment at the time of disposition will be recoverable from sales proceeds. Seaboard anticipates incurring additional losses from the operations of this Business until the sale of this Business is completed. As of October 1, 2005, the remaining carrying value of Seaboard's investments in and advances to this business total $4,060,000, including $2,758,000 of foreign currency translation gains recorded in other comprehensive income from this business which will be recognized in earnings upon completion of the sale. The investment and losses from the Business are included in the All Other segment. Effective May 9, 2005, Seaboard's Commodity Trading and Milling segment sold certain of its third party commodity trading operations as discussed in Note 2.
12 The following tables set forth specific financial information about each segment as reviewed by Seaboard's management. Operating income for segment reporting is prepared on the same basis as that used for consolidated operating income. Operating income, along with income or losses from foreign affiliates for the Commodity Trading and Milling segment, is used as the measure of evaluating segment performance because management does not consider interest and income tax expense on a segment basis. Sales to External Customers: Three Months Ended Nine Months Ended October 1, October 2, October 1, October 2, (Thousands of dollars) 2005 2004 2005 2004 Pork $259,185 $241,538 $ 756,652 $ 716,667 Commodity Trading and Milling 159,304 255,808 718,216 805,859 Marine 161,111 124,994 470,692 354,143 Sugar and Citrus 31,469 25,749 64,079 54,600 Power 21,145 12,768 56,726 43,892 All Other 4,565 6,605 20,703 20,283 Segment/Consolidated Totals $636,779 $667,462 $2,087,068 $1,995,444 Operating Income: Three Months Ended Nine Months Ended October 1, October 2, October 1, October 2, (Thousands of dollars) 2005 2004 2005 2004 Pork $ 42,719 $ 39,637 $ 141,011 $ 100,719 Commodity Trading and Milling 2,113 9,936 29,858 17,232 Marine 18,075 17,687 64,046 42,934 Sugar and Citrus 3,156 3,271 8,427 9,370 Power 2,072 2,105 6,640 3,359 All Other 521 962 2,351 2,326 Segment Totals 68,656 73,598 252,333 175,940 Corporate Items (3,273) (2,230) (7,722) (6,283) Consolidated Totals $ 65,383 $ 71,368 $ 244,611 $ 169,657 Income (Loss) from Foreign Affiliates: Three Months Ended Nine Months Ended October 1, October 2, October 1, October 2, (Thousands of dollars) 2005 2004 2005 2004 Commodity Trading and Milling $ 2,157 $ 1,365 $ 5,635 $ 3,953 Sugar and Citrus (230) 71 (17) 247 All Other (1,692) (1,333) (7,127) (4,328) Segment/Consolidated Totals $ 235 $ 103 $ (1,509) $ (128) Investments in and Advances to Foreign Affiliates: October 1, December 31, (Thousands of dollars) 2005 2004 Commodity Trading and Milling $ 31,023 $ 26,762 Sugar and Citrus 1,952 2,050 All Other 4,060 9,189 Segment/Consolidated Totals $ 37,035 $ 38,001
13 Total Assets: October 1, December 31, (Thousands of dollars) 2005 2004 Pork $ 738,736 $ 655,551 Commodity Trading and Milling 268,110 278,324 Marine 240,114 138,238 Sugar and Citrus 114,123 90,035 Power 91,889 77,978 All Other 9,969 13,924 Segment Totals 1,462,941 1,254,050 Corporate Items 195,967 182,644 Consolidated Totals $1,658,908 $1,436,694 During the third quarter of 2005, Seaboard revised its allocation of corporate items for operating income to the individual segments to primarily represent corporate services rendered to and costs incurred for each specific division with no allocation to individual segments of general corporate management oversight costs. Previously, administrative services provided by the corporate office were primarily allocated to the individual segments based on the size and nature of their operations with certain operating expenses not specifically allocated to individual segments. Operating income for each segment presented above for the three and nine months ended October 2, 2004 and the first six months of 2005 have been restated to reflect changes in the allocation of administrative services by the corporate office. Corporate assets include short-term investments, certain investments in and advances to foreign affiliates, fixed assets, deferred tax amounts and other miscellaneous items.
14 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations LIQUIDITY AND CAPITAL RESOURCES Summary of Sources and Uses of Cash Cash and short-term investments increased $163.4 million from December 31, 2004 reflecting the cash generated from operations and proceeds of $25.8 million from the sale of a portion of the commodity trading operations as noted below. Cash from operating activities totaled $264.0 million for the nine months ended October 1, 2005, of which $43.2 million was used for capital expenditures, $37.9 million was used to pay scheduled maturities on long-term debt and $47.5 million for the acquisition of Daily's as discussed below. Cash from operating activities for the nine months ended October 1, 2005 increased compared to the same period one year earlier primarily reflecting the increased earnings of the Pork, Commodity Trading and Milling, and Marine segments without corresponding increases in working capital needs as experienced in the prior year. In addition, ongoing working capital requirements have decreased for the Commodity Trading and Milling segment with the sale of some components of the commodity trading operations as noted below. Acquisitions, Capital Expenditures and Other Investing Activities As discussed in Note 2 to the Condensed Consolidated Financial Statements, effective May 9, 2005 Seaboard's Commodity Trading and Milling segment sold some components of its third party commodity trading operations for $26.5 million, subject to final adjustments. Transactions in process at the date of sale were completed by and the responsibility of Seaboard after the date of sale. Although Seaboard intends to continue competing in many of the markets of the sold operations, the volume of business will be less and thus the overall working capital requirements will be less in the future periods than periods prior to the sale. During the nine months ended October 1, 2005, Seaboard invested $43.2 million in property, plant and equipment, of which $5.3 million was expended in the Pork segment, $11.7 million was expended in the Commodity Trading and Milling segment, $15.5 million in the Marine segment, and $9.7 million in the Sugar and Citrus segment. For the Commodity Trading and Milling segment, $8.8 million was spent to purchase a used bulk vessel and make necessary improvements. For the Marine segment, $4.1 million was spent to purchase a crane and a previously chartered containerized cargo vessel, with the remaining expenditures primarily used to purchase cargo carrying equipment. In the Sugar and Citrus segment, the capital expenditures were primarily used for mill expansion, plantation development and harvesting equipment. All other capital expenditures are of a normal recurring nature and primarily include replacements of machinery and equipment, and general facility modernizations and upgrades. For the remainder of 2005 management has budgeted additional capital expenditures totaling $20.6 million, including $3.8 million for the Pork segment, $2.8 million for the Commodity Trading and Milling segment, $11.3 million in the Marine segment, and $2.2 million in the Sugar and Citrus segment. These budgeted expenditures are primarily of a normal recurring nature and include replacements of equipment and general facility upgrades and improvements with the exception of approximately $6.0 million to purchase cargo-carrying equipment for the Marine segment. Management anticipates funding these capital expenditures from internally generated cash, the use of available short-term investments or existing borrowing capacity. During the fourth quarter of 2004, Seaboard placed $0.7 million in escrow for a potential investment in an electricity generating company in the Dominican Republic. Initially, Seaboard's investment commitment was for a total of $3.4 million, or a 12.9% investment in this company, but during the second quarter of 2005, Seaboard increased its commitment to approximately $5.5 million for a total investment of less than 20% in this company. Seaboard has contracted to pay the remaining portion of the investment as soon as the local government, regulatory and banking approvals are received. However, because of delay in obtaining the requisite consents, both the seller and the purchaser presently have the right to cancel the transaction, although neither has yet exercised this right. It is unknown when, or if, the requisite consents will ever be obtained in order to complete the transaction. As discussed in Note 2 to the Condensed Consolidated Financial Statements, at the beginning of the third quarter of 2005, Seaboard completed the acquisition of a bacon processing company (Daily's) in exchange for $44.5 million in cash, plus preliminary working capital adjustments of approximately $3.1 million subject to final adjustments, a 4.74% equity interest in Seaboard Foods LLC (formerly Seaboard Farms, Inc.) valued at $44.5 million, a put right associated with the 4.74% interest in Seaboard Foods LLC valued at $6.7 million and $0.7 million of acquisition costs incurred. The cash payment was funded with proceeds from the sale of short-term investments.
15 Financing Activities and Debt During the second quarter of 2005, Seaboard allowed a $20.0 million committed line of credit to expire and also cancelled its $95.0 million subsidiary credit facility, leaving its $200.0 million five- year committed credit facility, and uncommitted lines totaling $29.4 million as of October 1, 2005. Subsequent to October 1, 2005, Seaboard reduced its five-year committed credit facility to $100 million as a result of the current levels of cash and short-term investments held by Seaboard. The borrowings outstanding as of October 1, 2005 of $2.0 million were under uncommitted lines. Outstanding standby letters of credit totaling $52.9 million reduced Seaboard's borrowing capacity under its committed credit line, primarily representing $42.7 million for Seaboard's outstanding Industrial Development Revenue Bonds and $9.5 million related to insurance coverages. In addition to funding Seaboard's planned capital expenditures as discussed above, Seaboard's remaining 2005 scheduled long-term debt maturities total $22.9 million. Management believes that Seaboard's current combination of internally generated cash, liquidity, capital resources and borrowing capabilities will be adequate to make these scheduled debt payments and support existing operations during fiscal 2005. Management periodically reviews various alternatives for future financings to provide additional liquidity for future operating plans, and intends to continue seeking opportunities for expansion in the industries in which Seaboard operates. See Note 6 to the Condensed Consolidated Financial Statements for a summary of Seaboard's contingent obligations, including guarantees issued to support certain activities of non-consolidated affiliates or third parties who provide services for Seaboard. RESULTS OF OPERATIONS Net sales decreased $30.7 million and increased $91.6 million for the three and nine month periods of 2005, respectively, compared to the same periods in 2004, respectively. The decrease for the quarter primarily reflect the sale of some components of Seaboard's third party commodity trading operations as discussed in Note 2 of the Condensed Consolidated Financial Statements. Partially offsetting the decrease in the quarter and primarily reflecting the increase in net sales for the nine month period of 2005 are improved average rates and volumes for marine cargo service, improved international markets for the Pork segment and, to a lesser degree, the acquisition of Daily's. Operating income decreased $6.0 million and increased $75.0 million for the three and nine month periods of 2005, respectively, compared to the same periods of 2004. The decrease for the 2005 quarter primarily represents lower sales volumes discussed above and significant losses from the mark-to-market of commodity futures and options in the Commodity Trading and Milling segment. The increase for the nine months of 2005 is primarily the result of the improved rates and volumes in the Marine segment, lower feed costs and improved international markets in the Pork segment and the significant losses recorded in 2004 from the mark-to-market of commodity futures and options in the Commodity Trading and Milling segment. Seaboard's operations primarily involve commodity based industries, which typically have cyclical upswings and downswings. For the past several quarters, Seaboard has experienced the positive effects from favorable pricing conditions in the Pork and Marine segments, while other segments have not experienced material negative conditions. If there is a cyclical downswing in the Pork or Marine industries or other industries in which Seaboard operates, Seaboard's results from operations will be adversely affected. Operating income for each segment presented below for the three and nine months ended October 2, 2004 and the first six months of 2005 have been restated to reflect changes in the allocation of administrative services by the corporate office as discussed in Note 8 to the Condensed Consolidated Financial Statements.
16 Pork Segment Three Months Ended Nine Months Ended October 1, October 2, October 1, October 2, (Dollars in millions) 2005 2004 2005 2004 Net sales $259.2 $241.5 $756.7 $716.7 Operating income $ 42.7 $ 39.6 $141.0 $100.7 Net sales for the Pork segment increased $17.7 million for the quarter and increased $40.0 million for the first nine months of 2005 as compared to 2004. The increases were primarily the result of the acquisition of Daily's, a processor of premium sliced and pre-cooked bacon as discussed in Note 2 to the Condensed Consolidated Financial Statements, and to a lesser degree, the result of strong demand in the international markets which provided opportunities to shift volumes and product mix to higher margin opportunities in international markets. The increases were partially offset by lower prices for pork products in the domestic markets. Management expects prices for the remainder of 2005 to be lower than prices in the similar period of 2004. Operating income for the Pork segment increased $3.1 million and $40.3 million for the three and nine month periods of 2005, respectively, compared to the same periods of 2004. For the quarter, the increase was primarily the result of the acquisition of Daily's. For the nine months, the increase is primarily a result of lower feed costs, a higher percentage of Seaboard-raised hogs processed which cost less than third party hogs and, to a lesser extent, the acquisition of Daily's. During the past several quarters, market prices for pork products were high relative to historic norms and there was a shift of more sales to the international markets. Historically high market prices have not been sustained over long periods of time. Management is unable to predict future market prices for pork products, feed costs and third party hogs, or how long the international market volumes will continue to grow as compared to the domestic market volumes. Management expects operating results to remain positive for the remainder of 2005. Commodity Trading and Milling Segment Three Months Ended Nine Months Ended October 1, October 2, October 1, October 2, (Dollars in millions) 2005 2004 2005 2004 Net sales $159.3 $255.8 $718.2 $805.9 Operating income $ 2.1 $ 9.9 $ 29.9 $ 17.2 Income from foreign affiliates $ 2.2 $ 1.4 $ 5.6 $ 4.0 As discussed in Note 2 to the Condensed Consolidated Financial Statements, effective May 9, 2005, Seaboard sold some components of its third party commodity trading operations. Seaboard intends to continue competing in many of the markets and routes associated with the sale transaction, although at a reduced level. Since Seaboard has conducted its commodity trading business with third parties, consolidated subsidiaries, and foreign affiliates on an interrelated basis and intends to continue trading to third parties in certain markets, operating income from the business sold cannot be clearly distinguished from the remaining operations of Seaboard's Commodity Trading and Milling segment without making numerous subjective assumptions primarily with respect to mark-to-market accounting. For the first half of 2005, this transaction did not have a material effect on net sales, net earnings or earnings per common share as transactions in process at the date of sale were completed by and the responsibility of Seaboard after the date of sale. Seaboard's revenues from the portion of the operations sold for the first two quarters of 2005 totaled approximately $317.3 million, compared to $312.0 million for the first two quarters of 2004. Net sales for the third quarter of 2005 for the third party commodity trading operations decreased $98.8 million, compared to the third quarter of 2004, and will continue to be comparably smaller than 2004 for the remainder of 2005 as a result of this transaction; however, the extent of the decrease beyond 2005 will depend on the ability to effectively compete in the markets. Net sales for the Commodity Trading and Milling segment decreased $96.5 and $87.7 million for the three and nine month periods of 2005, respectively, compared to the same periods of 2004. The decreases primarily reflect the sale of some components of Seaboard's third party commodity trading operations as discussed above. Operating income for this segment decreased $7.8 million and increased $12.7 million for the three and nine month periods of 2005, respectively, compared to the same periods of 2004, primarily reflecting the significant impact of marking to market the derivative contracts as discussed below and, for the quarter, the sale of operations discussed above. Included in operating income for the nine months of 2005 are $2.2 million of derivative gains related to derivative instruments sold in the sale transaction discussed above as a result of mark- to-market accounting discussed below. Additionally, both periods reflect improved margins on sales to certain
17 affiliates, and improved operations for certain milling locations. These improvements were partially offset by higher selling, general and administrative costs in 2005 primarily as a result of higher bad debt expenses. Due to the uncertain political and economic conditions in the countries in which Seaboard operates, management is unable to predict future sales and operating results, but anticipates positive operating income, excluding the potential effects of derivative gains or losses, to continue in 2005. Had Seaboard applied hedge accounting to its derivative instruments, operating income would have been higher by $4.6 million and lower by $0.3 million for the three and nine months of 2005, respectively, whereas operating income for the three and nine months of 2004 would have been higher by $0.4 million and $10.8 million, respectively. While management believes its foreign exchange contracts and commodity futures and options are economic hedges of its firm purchase and sales contracts, Seaboard does not perform the extensive record-keeping required to account for either type of derivative as hedges for accounting purposes. Accordingly, while the changes in value of the derivative instruments were marked to market, the changes in value of the firm purchase or sales contracts were not. As a result, operating income for the three and nine months of 2005 includes commodity derivative losses of $3.5 and $0.5 million, respectively, compared to losses of $0.4 million and $10.8 million for the same 2004 periods related to these mark-to-market adjustments. In addition, operating income for the three and nine months of 2005 includes foreign exchange contract losses of $1.1 million and gains of $0.7 million, respectively. During 2004, the foreign exchange contracts were accounted for as hedges. Seaboard's market risk exposure related to its derivative instruments has been reduced with the sale of the third party commodity trading business as discussed below. Income from foreign affiliates for the three and nine months of 2005 increased $0.8 million and increased $1.6 million, respectively, from the same 2004 periods primarily as a result of improved local operating conditions. Based on current political and economic situations in the countries in which the flour and feed mills operate, management cannot predict whether the foreign affiliates will remain profitable for the remainder of 2005. Marine Segment Three Months Ended Nine Months Ended October 1, October 2, October 1, October 2, (Dollars in millions) 2005 2004 2005 2004 Net sales $161.1 $125.0 $470.7 $354.1 Operating income $ 18.1 $ 17.7 $ 64.0 $ 42.9 Net sales for the Marine segment increased $36.1 million and $116.6 million for the three and nine month periods of 2005, respectively, compared to the same periods of 2004. These increases are the result of higher average cargo rates and higher cargo volumes in most markets reflecting the continuation of improved market conditions since the second half of 2004. Management cannot predict whether rates will continue to increase or be in an amount sufficient to cover increases in charter hire and fuel related expenses. Operating income for the Marine segment increased $0.4 million and $21.1 million for the three and nine months of 2005, respectively, compared to the same periods of 2004, primarily reflecting the increased rates and volumes discussed above, partially offset by higher charter hire expenses and fuel costs, especially during the third quarter of 2005. Although management cannot predict changes in future cargo rates, fuel related costs, charter hire expenses or to what extent changes in economic conditions will impact cargo volumes, it does expect this segment to remain profitable for the remainder of 2005. Sugar and Citrus Segment Three Months Ended Nine Months Ended October 1, October 2, October 1, October 2, (Dollars in millions) 2005 2004 2005 2004 Net sales $ 31.5 $25.7 $ 64.1 $ 54.6 Operating income $ 3.2 $ 3.3 $ 8.4 $ 9.4 Income (loss) from foreign affiliates $ (0.2) $ 0.1 $ 0.0 $ 0.2 Net sales for the Sugar and Citrus segment increased $5.8 million and $9.5 million, respectively, for the three and nine months of 2005 compared to the same periods of 2004 primarily as a result of higher sales volumes of sugar from increased purchases of sugar from third parties for resale and, to a lesser extent, increased production. Operating income decreased $0.1 million and $1.0 million, respectively, for the three and nine month periods of 2005 compared to the prior year as a result of operating losses from lower margins for the citrus operation partially offset by higher sugar sales discussed above. Management expects operating income will remain positive for 2005.
18 Power Segment Three Months Ended Nine Months Ended October 1, October 2, October 1, October 2, (Dollars in millions) 2005 2004 2005 2004 Net sales $ 21.1 $12.8 $ 56.7 $ 43.9 Operating income $ 2.1 $ 2.1 $ 6.6 $ 3.4 Net sales for the Power segment increased $8.3 million and $12.8 million for the three and nine month periods of 2005, respectively, compared to the same periods of 2004 primarily reflecting higher sales prices and in the third quarter, to a lesser extent, increased kilowatt hour production. Sales prices have increased during 2005 reflecting the increased cost of fuel. While Seaboard has entered into short-term and long-term sales contracts for most of its production capacity, at times management has curtailed production to avoid selling power in the spot market. During the third quarter of 2005, management began selling additional amounts in the spot market based on favorable spot market conditions. Management will continue to monitor the situation and will impose further curtailments to avoid sales to the spot market if market conditions do not remain favorable. Operating income remained flat at $2.1 million for the quarter and increased $3.2 million for the nine month period of 2005 compared to the same period of 2004. Although the third quarter operating income remained flat, the third quarter of 2004 included a reversal of $1.0 million of bad debt expense. For the nine months, the increase is primarily reflecting lower commission and bad debt expenses in 2005, partially offset by higher fuel costs in excess of increased sales prices and the impact of the strengthening peso on local expenses. During 2004, Seaboard terminated a business relationship with a one- time commission payment of $2.0 million during the second quarter of 2004. Management expects the economic situation in the Dominican Republic to remain relatively stable in the near term; however, higher fuel prices could pose a significant payment risk for the electric sector. Assuming fuel prices are stable or revert to more historical price levels, management expects to remain profitable for the remainder of 2005. All Other Three Months Ended Nine Months Ended October 1, October 2, October 1, October 2, (Dollars in millions) 2005 2004 2005 2004 Net sales $ 4.6 $ 6.6 $ 20.7 $ 20.3 Operating income $ 0.5 $ 1.0 $ 2.4 $ 2.3 Loss from foreign affiliate $ (1.7) $(1.3) $ (7.1) $ (4.3) The loss from foreign affiliate reflects Seaboard's share of losses from its equity method investment in a Bulgarian wine business. In 2005 Seaboard recorded 100% of the losses from this business compared to 37% in 2004. The loss in 2004 for this business includes a provision for inventory write-downs of which Seaboard recorded its share, $0.8 million, during the second quarter of 2004. Management expects additional losses from the operations of this business for the remainder of 2005. See Note 8 to the Condensed Consolidated Financial Statements for further discussion of this business and intentions to sell the business. Selling, General and Administrative Expenses Selling, general and administrative (SG&A) expenses increased by $6.5 million and $7.9 million during the three and nine months of 2005 compared to the same periods of 2004 primarily as a result of increases in the Marine segment reflecting increased selling costs related to the volume growth of this business, increases in the Commodity Trading and Milling segment primarily from higher bad debt expense and, to a lesser extent, the acquisition of Daily's in the Pork segment. Lower commission expenses and bad debt expense for the Power segment partially offset these increases for the nine month period. As a percentage of revenues, SG&A increased to 5.7% and 4.8% for the 2005 three and nine month periods, respectively, compared to 4.4% and 4.6%, respectively, for the same periods of 2004 primarily as a result of the sale of some components of Seaboard's third party commodity trading operations to Grindrod Limited as discussed in Note 2 to the Condensed Consolidated Financial Statements. Interest Expense Interest expense decreased $0.9 million and $3.7 million in the 2005 three and nine month periods, respectively, compared to the same periods of 2004 primarily reflecting the lower average level of short- term and long-term borrowings outstanding during 2005. During the second quarter of 2004, Seaboard repaid a significant portion of its short-term notes payable to banks with operating cash flows and there has been no need for additional borrowings.
19 Interest Income Interest income increased $1.6 million and $4.3 million in the three and nine month periods of 2005, respectively, compared to the same periods of 2004, primarily reflecting the higher level of average funds invested during 2005 and an increase in interest received on outstanding customer receivable balances in the Power segment. Minority and Other Noncontrolling Interests Minority and other noncontrolling interests expense increased $1.9 million and $2.0 million in the three and nine month periods of 2005, respectively, compared to the same periods of 2004, primarily reflecting the acquisition of Daily's as discussed in Note 2. Foreign Currency Gains (Losses) Seaboard realized net foreign currency losses of $0.4 million in the three and nine month periods of 2005, compared to gains of $5.0 and $3.5 million in the same periods of 2004. The strengthening of the Dominican Republic peso during the third quarter of 2004 created gains of $5.1 and $2.5 million for the three and nine months ended October 2, 2004 compared to losses of $0.8 and $0.3 million for comparable periods in 2005. Loss from the Sale of a Portion of Operations As discussed in Note 2 to the Condensed Consolidated Financial Statements, Seaboard sold some components of its third party commodity trading operations in May 2005. Because Seaboard does not use hedge accounting for its commodity and foreign exchange agreements, gains of $2.2 million from the mark-to-market of the sold derivative instruments were recorded in cost of sales prior to the date of the sale while the change in value of the related firm sales commitment was not, resulting in a loss on the sale from this transaction totaling $1.7 million, subject to final adjustments. Miscellaneous, Net Miscellaneous, net for the three and nine months of 2005 includes $3.1 million and $1.7 million, respectively, of gains from the mark-to- market of interest rate swap agreements compared to losses of $4.2 million and $4.0 million, respectively for the same periods in 2004. These swap agreements do not qualify as hedges for accounting purposes and accordingly, changes in the market value are recorded to earnings as interest rates change. The third quarter of 2005 also includes income of $0.8 million of put option value change as discussed in Note 2 to the Condensed Consolidated Financial Statements. Miscellaneous, net for the three and nine months ended October 2, 2004 also includes losses of $1.6 and $1.3 million, respectively, from the mark-to-market of commodity futures and options contracts that management does not view as direct economic hedges of its operations. Income Tax Expense The effective tax rate decreased during 2005 compared to 2004 primarily as a result of changes to the treatment of shipping income by the U.S. taxing authorities as further discussed in Note 4 of Condensed Consolidated Financial Statements. In addition, see Note 4 to the Condensed Consolidated Financial Statements for a discussion of the Internal Revenue Service's examination of Seaboard's federal income tax returns for 2000 through 2002. Other Financial Information On December 21, 2004, the Financial Accounting Standards Board (FASB) issued FASB Staff Position 109-2, "Accounting and Disclosure Guidance for the Foreign Earnings Repatriation Provision within the American Jobs Creation Act of 2004" (FSP109-2). FSP 109-2, which was effective upon issuance, allows companies time beyond the financial reporting period of enactment to evaluate the effect of the earnings repatriation provision on its plan for reinvestment or repatriation of foreign earnings for purposes of applying Statement of Financial Accounting Standards (SFAS) No. 109. Additionally, FSP 109-2 provides guidance regarding the required disclosures surrounding a company's reinvestment or repatriation of foreign earnings. Seaboard continues to evaluate this provision of the Act to determine the amount of foreign earnings to repatriate and expects to complete its evaluation in the fourth quarter of 2005. In November 2004, FASB issued SFAS No. 151, "Inventory Costs". This statement amends Accounting Research Board No. 43 to clarify the accounting for abnormal amounts of idle facility expense, freight, handling costs, and wasted material (spoilage). SFAS No. 151 requires that those items be recognized as current period charges regardless of whether they meet the criterion of "so abnormal". In addition, SFAS No. 151 requires that allocation of fixed production overheads to the costs of conversion be based on the normal capacity of the production facilities. Any costs outside the normal range would be considered a period expense instead of an inventoried cost. For Seaboard, this standard is effective for the fiscal year beginning January 1, 2006. The adoption of SFAS No. 151 is not expected to have a material impact on Seaboard's financial position or net earnings.
20 Item 3. Quantitative and Qualitative Disclosures About Market Risk Seaboard is exposed to various types of market risks from its day-to- day operations. Primary market risk exposures result from changing commodity prices, foreign currency exchange rates and interest rates. Changes in commodity prices impact the cost of necessary raw materials, finished product sales and firm sales commitments. Seaboard uses various grain and meal futures and options purchase contracts to manage certain risks of increasing prices of raw materials and firm sales commitments. Short sales contracts may then be used to offset any open purchase derivatives when the related commodity inventory is purchased in advance of the derivative maturity, effectively canceling the initial futures or option purchase contract. From time to time, hog futures are used to manage risks of increasing prices of live hogs acquired for processing. Because changes in foreign currency exchange rates impact the cash paid or received on foreign currency denominated receivables and payables, Seaboard manages certain of these risks through the use of foreign currency forward exchange agreements. Changes in interest rates impact the cash required to service variable rate debt. From time to time, Seaboard uses interest rate swaps to manage risks of increasing interest rates. The nature of Seaboard's market risk exposure related to these items has not changed materially since December 31, 2004, although the amount of commodity futures and option contracts and foreign exchange contracts decreased considerably with the sale of a portion of the third party trading operations as discussed in Note 2 to the Condensed Consolidated Financial Statements. At October 1 2005, Seaboard had net trading contracts to purchase 1,161,000 bushels of grain (fair value of negative $3,516,000) and to purchase 14,000 tons of meal (fair value of negative $87,000). At December 31, 2004, Seaboard had net trading contracts to purchase 7,626,000 bushels of grain (fair value of negative $304,000) and 81,000 tons of meal (fair value of negative $1,492,000). At October 1, 2005, Seaboard had net agreements to exchange the equivalent of $32,882,000 of South African rand at an average contractual exchange rate of 6.40 ZAR to one U.S. dollar. At December 31, 2004, Seaboard had net agreements to exchange the equivalent of $98,476,000 of South African rand at an average contractual exchange rate of 6.14 ZAR to one U.S. dollar. Item 4. Controls and Procedures Evaluation of Disclosure Controls and Procedures - Seaboard's management evaluated, under the direction of our chief executive and chief financial officers, the effectiveness of Seaboard's disclosure controls and procedures as defined in Exchange Act 15(d) - 15(e) as of October 1, 2005. Based upon and as of the date of that evaluation, Seaboard's chief executive and chief financial officers concluded that Seaboard's disclosure controls and procedures were effective to ensure that information required to be disclosed in the reports it files and submits under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported as and when required. It should be noted that any system of disclosure controls and procedures, however well designed and operated, can provide only reasonable, and not absolute, assurance that the objectives of the system are met. In addition, the design of any system of disclosure controls and procedures is based in part upon assumptions about the likelihood of future events. Due to these and other inherent limitations of any such system, there can be no assurance that any design will always succeed in achieving its stated goals under all potential future conditions. Change in Internal Controls - During the third quarter of 2005, Seaboard completed the acquisition of Daily's. Management is currently completing post merger integration plans which include converting certain accounting information systems and is in the process of documenting and evaluating internal controls with respect to Daily's. Although management does not consider it material to its results of operations, Seaboard intends to extend its Sarbanes-Oxley Act of 2002 Section 404 compliance program to include Daily's with an effective date of July 1, 2006. Except as set forth above, there has been no change in Seaboard's internal control over financial reporting that occurred during the fiscal quarter ended October 1, 2005 that has materially affected, or is reasonably likely to materially affect, Seaboard's internal control over financial reporting.
21 PART II - OTHER INFORMATION Item 1. Legal Proceedings In order to settle threatened additional litigation with Sierra Club, Seaboard agreed to conduct an investigation to determine if corrective action is required at three farms purchased from PIC located in Kingfisher and Major Counties in Oklahoma according to an agreed-upon process. Based on the investigation, it has been determined that two farms do not require any corrective action. The investigation at the one remaining farm is continuing; however, it has been determined that the lagoon at this farm is a likely source of elevated nitrates in the ground water. Seaboard advised the Oklahoma Department of Agriculture, Food & Forestry as to this fact, and is in the process of determining the necessary corrective action. The cost of the repairs and any other implications is not known at this time, but if a new lagoon is constructed, the cost could exceed $1 million. The farm was one of the farms purchased from PIC International Group, Inc. (PIC). Seaboard has given notice to PIC as to its right to indemnification from any loss as a result of the lagoon. To date, PIC has declined to provide indemnification. Seaboard's subsidiary, Seaboard Foods, Inc. (Seaboard Foods), is subject to an ongoing Unilateral Administrative Order (RCRA Order) pursuant to Section 7003 of the Resource Conservation and Recovery Act, as amended, 42 U.S.C. Sec. 6973 (RCRA), filed by the United States Environmental Protection Agency (EPA) on June 29. These same farms are the subject of a Notice of Violation letter received from the State of Oklahoma, alleging that Seaboard Foods has violated various provisions of state law and the operating permits based on the same conditions which gave rise to the RCRA Order. Seaboard Foods disputes the RCRA Order and the State of Oklahoma's contentions on legal and factual grounds, and advised the EPA that it won't comply with the RCRA Order, as written. Notwithstanding, Seaboard Foods has undertaken an extensive investigation under the RCRA Order, and has had significant discussions with the EPA and the State of Oklahoma, proposing to pay a civil penalty and to undertake continued monitoring and take a number of corrective actions with respect to the farms, and one additional farm, in order to attempt to settle the RCRA Order and the Oklahoma Notice of Violation Originally, EPA advised Seaboard Foods that any such settlement must include a civil fine of $1,200,000, but EPA has since reduced the amount of its demand for a civil penalty to $345,000. Seaboard Foods believes that the EPA has no authority to impose a civil fine, but settlement discussions are continuing. A tentative verbal settlement has been reached with the State of Oklahoma which would require Seaboard Foods to pay a fine of $100,000 and to undertake agreed upon supplemental environmental projects at a cost of $80,000. The settlement is subject to the final terms being agreed to and the approval of the Oklahoma Board of Agriculture. Irrespective of the settlement, Seaboard Foods has completed or is in the process of completing many of the proposed corrective actions at the relevant farms. PIC is indemnifying Seaboard with respect to the action pursuant to an indemnification agreement which has a $5 million limit. To date, the $5 million limit has not been exceeded. If the tentative settlement with the State of Oklahoma is agreed to, the estimated cumulative costs which will be expended will total approximately $6.9 million, not including the additional legal costs required to negotiate the settlement or the penalties demanded by EPA and tentatively agreed to with the State of Oklahoma. If the measures taken pursuant to the settlement are not effective, other measures with additional costs may be required. PIC has advised Seaboard that it is not responsible for the costs in excess of $5 million. Seaboard disputes PIC's determination of the costs to be included in the calculation to determine whether the $5 million limit will be exceeded and believes that the costs to be considered are less than $5 million, such that PIC is responsible for all such costs and penalties, except for approximately $180,000 of estimated costs that would be incurred over 5 years subsequent to the settlement for certain testing and sampling. Seaboard has agreed to conduct such testing and sampling as a part of the sampling it conducts in the normal course of operations and believes that the incremental costs incurred to conduct such testing and sampling will be less than $180,000. Seaboard also believes that a more general indemnity agreement would require indemnification of liability in excess of $5 million (excluding the estimated $180,000 cost for testing and sampling), although PIC disputes this. Item 6. Exhibits 4.1 Notice of Reduction of Aggregate Commitments under Credit Agreement dated as of December 3, 2004 among Seaboard Corporation, Bank of America, N.A., Scotia Capital, Inc., Harris Trust and Savings Bank and Suntrust Bank and the Other Lenders Party Hereto 31.1 Certification of the Chief Executive Officer Pursuant to Exchange Act Rules 13a-14(a)/15d-14(a), as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
22 31.2 Certification of the Chief Financial Officer Pursuant to Exchange Act Rules 13a-14(a)/15d-14(a), as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 32.1 Certification of the Chief Executive Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 32.2 Certification of the Chief Financial Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 This Form 10-Q contains forward-looking statements with respect to the financial condition, results of operations, plans, objectives, future performance and business of Seaboard Corporation and its subsidiaries (Seaboard). Forward-looking statements generally may be identified as: statements that are not historical in nature; and statements preceded by, followed by or that include the words "believes," "expects," "may," "will," "should," "could," "anticipates," "estimates," "intends," or similar expressions. In more specific terms, forward-looking statements, include, without limitation: statements concerning projection of revenues, income or loss, capital expenditures, capital structure or other financial items; statements regarding the plans and objectives of management for future operations; statements of future economic performance; statements regarding the intent, belief or current expectations of Seaboard and its management with respect to: (i) Seaboard's ability to obtain adequate financing and liquidity, (ii) the price of feed stocks and other materials used by Seaboard, (iii) the sale price or market conditions for pork products from such operations, (iv) the price or market conditions for other products and services, (v) the ability of Seaboard's Commodity Trading and Milling segment to successfully continue competing in the markets and routes associated with the assets sold to Grindrod Limited, (vi) the charter hire rates and fuel prices for vessels, (vii) the demand for power, related spot market prices and collectibility of receivables in the Dominican Republic, (viii) the effect of the fluctuation in exchange rates for the Dominican Republic pesos, (ix) the potential effect of Seaboard's investment in a wine business on the consolidated financial statements, (x) the potential impact of various environmental actions pending or threatened against Seaboard, (xi) the potential impact of the American Jobs Creation Act, (xii) the potential impact of the current IRS audit, (xiii) statements concerning profitability of any of Seaboard's segments or (xiv) other trends affecting Seaboard's financial condition or results of operations, and statements of the assumptions underlying or relating to any of the foregoing statements. Forward-looking statements are not guarantees of future performance or results. They involve risks, uncertainties and assumptions. Actual results may differ materially from those contemplated by the forward- looking statements due to a variety of factors. The information contained in this report, including without limitation the information under the headings "Management's Discussion and Analysis of Financial Condition and Results of Operations," identifies important factors which could cause such differences.
23 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. DATE: November 4, 2005 Seaboard Corporation by: /s/ Robert L. Steer Robert L. Steer, Senior Vice President, Treasurer and Chief Financial Officer (principal financial officer) by: /s/ John A. Virgo John A. Virgo, Vice President, Corporate Controller and Chief Accounting Officer (principal accounting officer)
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