SECURITIES AND EXCHANGE COMMISSION
FORM 10-Q
Commission file number 000-20557
THE ANDERSONS, INC.
(419) 893-5050(Telephone Number)
(Former name, former address and former fiscal year,if changed since last report.)
Indicate by check ü 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 [ü] No [ ]
Indicate by check ü whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes [ü] No [ ]
The registrant had 7.3 million common shares outstanding, no par value, at November 1, 2004.
INDEX
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Part I. Financial Information
Item 1. Financial Statements
The Andersons, Inc.
See notes to condensed consolidated financial statements
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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Forward Looking Statements
The following Management’s Discussion and Analysis contains various “forward-looking statements” which reflect the Company’s current views with respect to future events and financial performance. These forward-looking statements are subject to certain risks and uncertainties, including but not limited to those identified below, which could cause actual results to differ materially from historical results or those anticipated. The words “believe,” “expect,” “anticipate,” “will” and similar expressions identify forward-looking statements. Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of their dates. The Company undertakes no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise. The following factors could cause actual results to differ materially from historical results or those anticipated: weather; supply and demand of railcars and commodities including grains, fertilizer and other basic raw materials; market prices for grains and the potential for increased margin requirements; environmental and governmental policies; competition; economic conditions; risks associated with acquisitions; interest rates; and income taxes.
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Critical Accounting Policies and Estimates
Our critical accounting estimates, as described in our 2003 Annual Report on Form 10-K, have not materially changed during the first nine months of 2004.
Comparison of the three months ended September 30, 2004 with the three months ended September 30, 2003:
Sales and merchandising revenues for the three months ended September 30, 2004 totaled $250.7 million, a decrease of $2.3 million, or 1% from the third quarter of 2003. Sales of grain and fertilizer in the Agriculture Group were down $9.4 million, or 5%. Grain sales make up 70-80% of the total annual sales in the Agriculture Group. Approximately 50% of grain bushels purchased are done so using forward contracts. On the sell-side, approximately 90% of grain bushels sold are done so under forward contracts. Grain sales were down $24.6 million, or 17%, due to a 9% decrease in the average price per bushel sold along with an 8% decrease in volume. The reductions in sales volume occurred in both soybeans and wheat. Sales of fertilizer in the plant nutrient division were up $15.2 million, or 52%, due to a 6% increase in tons sold and a 43% increase in the weighted average price per ton sold. Significant price increases have occurred in the primary commodities handled by the division - urea, phosphates and potash. Generally, these increases can be passed through to the Company’s customers, although price increases may eventually drive decreases in volume used by the farmer / consumer. During a period of anticipated price increases, volume may increase as customers are attempting to lock in pricing on their immediate demand.
Merchandising revenues in the Agriculture Group were up $0.4 million, or 12%, due to increases in grain drying and mixing income and income earned on the Company’s grain market positions. Space income, one of the more volatile components of grain merchandising revenue, was down slightly from the third quarter of 2003 to the third quarter of 2004. Space income is income earned on grain held for our account or for our customers and includes storage fees earned and appreciation in the value of grain owned. Grain inventories on hand at September 30, 2004 were 41.7 million bushels, of which 8.6 million bushels were stored for others. This compares to 28.7 million bushels on hand at September 30, 2003, of which 6.1 million bushels were stored for others. September deliveries from the 2004 corn and soybean harvest are significantly higher in the third quarter of 2004 than in the prior year and have increased bushels on hand at the end of September 2004. In the first quarter of 2004, the Company completed the purchase of a
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3.5 million bushel capacity grain elevator, located in Oakville, Indiana. The Company had leased and operated this facility since September of 2003.
As of this filing, corn and soybeans delivered to the Company are of very good quality. Acres planted exceeded last year for corn and are slightly below last year for soybeans. The United States Department of Agriculture is projecting record high yields in Ohio, Indiana and Illinois and very good yields in Michigan as well for both corn and soybeans. The wheat harvest was completed in the third quarter with wheat production in the four key states down this year. The Company has received slightly less wheat bushels in the third quarter of 2004 than in prior years, although more than was expected. The quality of wheat received was highly variable and the ability to purchase at slightly lower qualities and blend to selling specifications has created the increased drying and mixing income noted previously. The overall higher yields have also helped drive the fertilizer demand higher as fertilizer distributors anticipate high demand from customers for the next crop year.
The Rail Group had a $10.1 million, or 110%, increase in sales. There was a $0.8 million increase in sales of railcars to customers or financial institutions, a $2.5 million increase in revenues generated from the Company’s existing lease fleet and a $6.0 million increase in lease fleet income was generated on the newly acquired railcar and locomotive fleet. Railcars under management at September 30, 2004 were 13,591 compared to 6,085 under management at September 30, 2003. The railcar utilization rate (railcars under management in lease service, exclusive of railcars managed for third party investors) on the railcars fleet before the February 2004 fleet acquisition, increased from 89% to 96% from September 30, 2003 to September 30, 2004. The railcar utilization rate for the fleet acquired in February was 86% at September 30, 2004.
Recent lease renewals and higher utilization have provided evidence of an improved railcar leasing market. Currently, the supply of idle railcars is low in the areas that we serve, driving up our utilization and lease rates. We have also signed leases for longer terms than in the recent depressed market. The railcar repair and metal fabrication shops had a $0.8 million, or 66%, sales increase when compared to the third quarter of 2003.
The Processing Group had a $2.7 million, or 11% decrease in sales resulting primarily from a 10% decrease in volume, all in the lawn businesses, and a 1% decrease in the average price per ton sold. In the consumer and industrial lawn businesses, where we serve as contract manufacturer for several large “brand” companies, a private label manufacturer and also manufacture our own brands, volume was down 21% and the average price per ton sold was up 3%.
The professional lawn business had an 11% decrease in volume and a 1% increase in the average price per ton sold. Tons sold in the professional market include higher margin tons sold for golf course application and lower margin tons sold to lawn care operators. Pressure on golf course profitability coupled with some low-priced competition has reduced demand for premium golf course fertilizers. The cob-based business, a much
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smaller component of the Processing Group, had a 10% increase in sales, primarily due to a 14% increase in volume.
Retail Group sales were down 2% when compared to the third quarter of 2003. While the Columbus, Ohio market had an increase, both the Lima, Ohio and Toledo, Ohio area stores posted decreases. Average customer counts were down slightly in the third quarter of 2004 when compared to the third quarter of 2003, but the average customer purchase was slightly increased. Significant new competition in the Toledo market from national “Big Box” retailers is believed to be causing most of the pressure on sales. October sales are continuing at approximately the same levels as the prior year.
Gross profit for the third quarter of 2004 totaled $40.7 million for the Company, an increase of $10.5 million, or 35%, from the third quarter of 2003. Gross profit in the Agriculture Group was up $4.0 million, or 35%, resulting primarily from increased gross profit on grain and fertilizer sold along with the increase in merchandising revenues mentioned previously. The Company was able to transact some high margin sales for high quality wheat and soybeans in the third quarter at a time when availability of this quality of grain was limited. The fertilizer gross profit increase resulted from the increased volume mentioned previously along with an increase in the average per ton margin.
Gross profit in the Rail Group increased $6.4 million, or 207%. This increase included $4.0 million of increased lease fleet income ($3.4 million on the newly acquired fleet), a $2.5 million increase in gross profit on car sales and a slight reduction in gross profit in the repair and fabrication shops. Lease fleet income is the gross lease (rent) and fleet management income less direct costs of cars leased to customers (rental expense, depreciation, property tax and maintenance).
Gross profit for the Processing Group decreased $0.2 million, or 6%, primarily from the decreased volume in the lawn business mentioned previously. Costs per ton in the lawn business have risen 3% due primarily to the increased cost of urea and other raw materials. Increases in the average selling price per ton, however, have more than offset the increased costs. Gross profit in the smaller cob business decreased slightly.
Gross profit in the Retail Group increased $0.3 million, or 3%, from the third quarter of 2003. This was due primarily to a 5% increase in sales margins due to mix on reduced sales.
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Operating, administrative and general expenses for the third quarter of 2004 totaled $38.8 million, a $5.1 million, or 15%, increase from the third quarter of 2003. Included in this increase is $1.4 million related to growth in the Rail and Agriculture Groups. The remaining $3.7 million increase for the existing business is 11% higher than the third quarter of 2003 and represents a variety of cost increases, most notably $1.4 million for labor, benefits and performance incentive compensation, $0.6 million for additional maintenance and $0.5 million for external costs for complying with the Sarbanes-Oxley Act. There was no measurable change in full time employees from September 2003 to September 2004.
Fees paid to external providers to date relating to our project to comply with the Securities and Exchange Commission requirement for Management’s Report on Internal Control over Financial Reporting are noted above; however, we anticipate increased expenses for this project in the fourth quarter of 2004. Included in the staffing increase noted above are positions directly and indirectly related to this ongoing requirement. In addition, a significant amount of time and energy is being spent on this project.
Interest expense for the third quarter of 2004 was $2.5 million, a $0.9 million, or 54%, increase from 2003. Average 2004 daily short-term borrowings were 91% lower than the third quarter of 2003 and the average daily short-term interest rate increased from 1.8% for the third quarter of 2003 to 2.1% for the third quarter of 2004. The Company’s outstanding recourse long-term debt (including current maturities) increased 5% from September 30, 2003 to September 30, 2004. Additionally, the Company’s non-recourse, securitized debt (issued to complete the railcar acquisition in the first quarter of 2004) was reduced by 8% in the quarter. Long-term interest increased 87% for the quarter due primarily to the 2004 issuance of securitized debt.
As a result of the above, the pretax income of $1.4 million for the third quarter of 2004 was $5.0 million better than the pretax loss of $3.6 million recognized in the third quarter of 2003. Typically, the Company’s third quarter is a loss quarter as a result of the normal cycles of the businesses in which we operate. Income tax expense of $0.3 million was provided at an effective rate of 23.0%. In the third quarter of 2003, the income tax benefit was provided at 34.7%. The Company’s actual 2003 effective tax rate was 34.9%.
The third quarter 2004 effective tax rate of 23.0% is lower than the expected 2004 annual effective tax rate of 37.7% due to recognizing in the third quarter a tax benefit associated
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with the U.S. Extraterritorial Income Regime, or ETI. Prior to the passing of federal tax legislation on October 22, 2004, there were various tax proposals before the U.S. Congress that provided for a reduced ETI tax benefit in 2004. The recently passed legislation provides for 100% ETI benefit in 2004 and the Company adjusted its assumptions around the benefit it was likely to receive in the third quarter as it monitored the status of the pending legislation.
Third quarter income tax expense consists of $0.1 million attributable to U.S. operations and $0.2 million attributable to foreign operations.
Comparison of the nine months ended September 30, 2004 with the nine months ended September 30, 2003:
Sales and merchandising revenues for the nine months ended September 30, 2004 totaled $901.6 million, an increase of $97.8 million, or 12%, from the first nine months of 2003. Sales of grain and fertilizer in the Agriculture Group were up $80.8 million, or 16%. Grain sales were up $41.6 million, or 11%, due to a 3% increase in average price per bushel sold and an 8% increase in volume. This volume increase resulted from continued high demand for grain. This increased demand has lowered the overall grain stocks worldwide and increased our average price per bushel sold. Sales of fertilizer in the plant nutrient division were up $39.2 million, or 28%, due to a 19% increase in the average price per ton sold coupled with a 7% increase in volume. A portion of the price increase relates to increased commodity prices for the three key raw materials used by the plant nutrient division. Generally, this increase can be passed through to customers, although price increases may also drive decreases in volume.
Merchandising revenues in the Agriculture Group were up $4.9 million, or 33%, due to increases in grain space income and income earned on the Company’s grain market positions as well as income from storing and applying fertilizer. Space income is income earned on grain held for our account or for our customers and includes storage fees earned and appreciation in the value of grain owned.
The Rail Group had a $17.3 million, or 66%, increase in sales. This increase included $6.0 million of additional revenue generated from the Company’s existing lease fleet and a $15.3 million increase in lease fleet income that was generated on the newly acquired railcar and locomotive fleet partially offset by a $4.8 million decrease in sales of railcars to customers or financial institutions. Sales in the railcar repair and fabrication shops were up $0.8 million.
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The Processing Group had a $7.0 million, or 6%, decrease in sales resulting primarily from an 11% decrease in volume, partially offset by a 5% increase in the average price per ton sold. In the professional lawn business, serving the golf course and lawn care operator markets, volume was down 10% and the average price per ton sold was unchanged from the first nine months of 2003. In the consumer and industrial lawn businesses, where we serve as contract manufacturer for several large “brand” companies, a private label manufacturer and also manufacture our own brands, volume was down 16%, partially offset by a 12% increase in the average price per ton sold. The cob-based businesses, a much smaller component of the Processing Group, had a 1% increase in sales primarily due to a 9% increase in volume, partially offset by a 7% reduction in the average price per ton sold.
The Retail Group had a $1.8 million, or 1%, increase in same-store sales in the first nine months of 2004 when compared to the first nine months of 2003. The Columbus, Ohio market had an increase while the Toledo and Lima, Ohio stores combined had decreased sales of approximately 1%. Sales increases were stronger in the first quarter and have slowed in the second and third quarters. Year to date customer counts are nearly 1% ahead of last year with a comparable increase in the average sale per customer.
Gross profit for the first nine months of 2004 totaled $132.9 million for the Company, an increase of $22.0 million, or 20%, from the first nine months of 2003. The Agriculture Group had an $8.2 million, or 17%, increase in gross profit, resulting primarily from the increase in merchandising revenues mentioned previously along with a significant increase in margins on grain sales recognized primarily in the third quarter. Gross profit in the plant nutrient division also increased by $0.2 million on volume improvements.
Gross profit in the Rail Group increased $12.8 million, or 149%. This increase included an increase of $10.7 million for increased lease fleet income ($8.6 million on the newly acquired fleet), a $2.0 million increase in gross profit on car sales and a $0.1 million increase in gross profit in the repair and fabrication shops. Lease fleet income is the gross lease (rent) and fleet management income less direct costs of cars leased to customers (rental expense, depreciation, property tax and maintenance).
Gross profit for the Processing Group decreased $0.5 million, or 3%. The lawn businesses experienced a decrease of $0.8 million primarily related to the overall 14% decrease in volume, coupled with an 8% increase in average cost per ton. The consumer / industrial average selling price per ton increase noted previously, however, allowed for an overall 10% increase in gross profit per ton for the lawn businesses. The cob-based
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business experienced a $0.2 million, or 13%, increase in gross profit on both volume and margin improvement.
Gross profit in the Retail Group increased $1.5 million, or 4%, from the first nine months of 2003. This was due to the 1% increase in sales discussed previously and a modest increase in margin resulting from changes in the mix of products sold.
Operating, administrative and general expenses for the first nine months of 2004 totaled $111.7 million, an increase of $10.6 million, or 11%, as compared to the first nine months of 2003. Included in this increase is $3.7 million related to growth in the Rail and Agriculture Groups. The remaining $6.9 million increase for the existing business is 7% higher than the first nine months of 2003 and represents a variety of cost increases, most notably labor, benefits and performance incentive compensation for employees, contract labor, maintenance and professional fees. There was no measurable change in full time employees from September 2003 to September 2004.
Interest expense for the first nine months of 2004 was $7.9 million, a $1.8 million, or 29%, increase from 2003. Average 2004 daily short-term borrowings were 7% lower than the first nine months of 2003 and the average daily short-term interest rate decreased from 2.1% for the first nine months of 2003 to 1.9% for the first nine months of 2004. The Company’s outstanding recourse long-term debt (including current maturities) increased 5% from September 30, 2003 to September 30, 2004. Additionally, the Company issued non-recourse, securitized debt of $86.4 million to complete the railcar acquisition in the first quarter of 2004 and has since repaid $9.3 million. Long-term interest for the period increased 49% due primarily to this new issuance.
As a result of the above, the pretax income of $17.4 million for the first nine months of 2004 was 133% higher than the pretax income of $7.5 million recognized in the first nine months of 2003. Income tax expense of $6.6 million was provided at 37.7%. In the first nine months of 2003, income tax expense was provided at 33.7%. The Company’s actual 2003 full-year effective tax rate was 34.9%. The expected annual 2004 tax rate of 37.7% anticipates a higher state and local income tax rate
The nine months income tax expense consists of $6.0 million attributable to U.S. operations and $0.6 million attributable to foreign operations.
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Liquidity and Capital Resources
The Company’s operations provided cash of $46.6 million in the first nine months of 2004, an increase of $38.2 million from the same period in 2003. Short-term borrowings used to fund these operations decreased $37.4 million from December 31, 2003. Net working capital at September 30, 2004 was $97.6 million, an $8.1 million increase from December 31, 2003 and a $15.0 million increase from the September 30, 2003 working capital.
The Company has significant short-term lines of credit available to finance working capital, primarily inventories and accounts receivable. In 2002, the Company entered into a borrowing arrangement with a syndicate of banks. The borrowing arrangement was amended and renewed in the third quarter of 2004. The agreement provides the Company with $100 million in short-term lines of credit and an additional $100 million in a three-year line of credit. In addition, the amended agreements include a flex line allowing the company to increase the available short-term line by $50 million. The short-term line of credit available was temporarily increased to $240 million in the second quarter in response to business needs. At July 1, 2004, the available short-term lines were reduced back to $200 million. Prior to the syndication agreement, the Company managed several separate short-term lines of credit. The Company had drawn $10.6 million on its short-term line of credit at September 30, 2004. Peak short-term borrowing for the Company to date is $188.5 million on April 8, 2004. During the third quarter of 2004, there were thirty days when the Company had no short-term lines of credit outstanding. Typically, the Company’s highest borrowing occurs in the spring due to seasonal inventory requirements in the fertilizer and retail businesses, credit sales of fertilizer and a customary reduction in grain payables due to the cash needs and market strategies of grain customers.
The Company utilizes interest rate contracts to manage a portion of its interest rate risk on both its short and long-term debt and lease commitments. At September 30, 2004, the fair value of these derivative financial instruments (primarily interest rate swaps and interest rate caps) was less than $0.1 million and was recorded in the consolidated balance sheet.
A quarterly cash dividend of $0.075 per common share was paid in January, April and July 2004. Cash dividends of $0.07 per common share were paid quarterly in 2003. A cash dividend of $0.08 per common share was declared on October 1, 2004 and was paid on October 22, 2004. The Company made income tax payments of $6.9 million in the first nine months of 2004 and expects to make payments totaling approximately $0.2 million for the remainder of 2004. During the first nine months of 2004, the Company issued approximately 72 thousand shares to employees and directors under its share compensation plans.
Total capital spending for 2004 on property, plant and equipment could approximate $26.4 million. Capital spending through the first nine months of 2004 has totaled $11.0 million which includes the acquisition of the Oakville, Indiana grain facility completed in
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the first quarter of 2004 and $0.7 million on information systems upgrades. The remaining spending was on projects less than $0.5 million. Potential significant projects for the remainder of the year could be delayed into 2005 or cancelled.
In addition to the spending on conventional property, plant and equipment, the Company also expects to spend up to $40.0 million in 2004 for the purchase of additional railcars and capitalized modifications on railcars that may then be sold, financed off-balance sheet or owned by the Company for lease to customers. This amount is in addition to the significant railcar purchase described in Note B, where the Company purchased approximately 6,700 railcars and 48 locomotives in a fleet acquisition completed in February 2004 for $83.7 million plus $1.4 million in transaction costs. As part of this acquisition, the Company also acquired management contracts for an additional 2,400 railcars owned by third-party investors. The majority of the purchased railcars acquired are in lease service. To finance the transaction, $86.4 million of non-recourse, securitized debt was issued by the Company or its subsidiaries. The Company has spent an additional $24.1 million on railcars, most of which were then sold or financed.
The Company increased its investment in Lansing Grain Company, LLC in February 2004. The Company now owns 22.1% of the equity and accounts for it on the equity method. The Company also holds an option to increase its investment in each of the next four years with the potential of attaining majority ownership in 2008.
Certain of the Company’s long-term borrowings include provisions that impose minimum levels of working capital and equity, impose limitations on additional debt and require that grain inventory positions be substantially hedged. The Company was in compliance with all of these provisions at September 30, 2004. In addition, certain of the long-term borrowings are secured by first mortgages on various facilities or are collateralized by railcar assets. Additional long-term debt financing of $7.5 million was obtained in the second quarter and the Company pledged, as collateral, the grain facility it acquired in Oakville, Indiana in the first quarter of 2004. The new long-term debt obtained as part of the acquisition described in Note B is securitized by the assets held by the three wholly-owned bankruptcy-remote entities.
Because the Company is a significant consumer of short-term debt in peak seasons and the majority of this is variable rate debt, increases in interest rates could have a significant impact on the profitability of the Company. In addition, periods of rising grain prices could require the Company to make additional margin deposits on its CBOT futures contracts. Conversely, in periods of declining prices, the Company receives a return of cash. The marketability of the Company’s grain inventories and the availability of short-term lines of credit enhance the Company’s liquidity. In the opinion of management, the Company’s liquidity is adequate to meet short-term and long-term needs.
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Contractual Obligations
Future payments due under debt and lease obligations as of September 30, 2004 are as follows:
There are short-term acquisition liabilities that include minimum payments. There are additional contingent sales-based payments to the seller that have not triggered to date and would not be material to the Company if they trigger in the future. The contingency period ends May 2005.
The Company had standby letters of credit outstanding of $8.9 million at September 30, 2004, of which $8.1 million is a credit enhancement for industrial revenue bonds included in the contractual obligations table above.
The Company’s grain inventories include the value of forward purchase contracts to buy grain. These contracts are marked to the market price and require performance in future periods. The terms of these contracts are consistent with industry standards.
Approximately 76% of the operating lease commitments above relate to 3,426 railcars and 30 locomotives that the Company leases from financial intermediaries. See the following section on Off-Balance Sheet Transactions.
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The Company is subject to various loan covenants as highlighted previously. The Company is and has been in compliance with its covenants; noncompliance could result in default and acceleration of long-term debt payments. The Company does not anticipate noncompliance with its covenants.
Off-Balance Sheet Transactions
The Company’s Rail Group utilizes leasing arrangements that provide off-balance sheet financing for its activities. The Company leases railcars from financial intermediaries through sale-leaseback transactions, the majority of which involve operating leasebacks. Railcars owned by the Company, or leased by the Company from a financial intermediary, are generally leased to a customer under an operating lease. The Company also arranges non-recourse lease transactions under which it sells railcars or locomotives to a financial intermediary, and assigns the related operating lease to the financial intermediary on a non-recourse basis. In such arrangements, the Company generally provides ongoing railcar maintenance and management services for the financial intermediary, and receives a fee for such services. On most of the railcars and locomotives that are not on its balance sheet, the Company holds an option to purchase these assets at the end of the lease.
The following table describes the railcar and locomotive positions at September 30, 2004.
In addition, the Company manages 1,976 railcars for third-party customers or owners for which it receives a fee.
The Company has future lease payment commitments aggregating $38.1 million for the railcars leased by the Company from financial intermediaries under various operating leases. Remaining lease terms vary with none exceeding 8 years. The majority of these railcars have been leased to customers at September 30, 2004 over similar terms. This segment manages risk by match funding (which means matching terms between the lease to the customer and the funding arrangement with the financial intermediary), where possible, and ongoing evaluation of lessee credit worthiness. In addition, the Company
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prefers non-recourse lease transactions, whenever possible, in order to minimize its credit risk.
As described in Note B, the above car counts include railcars and locomotives that were purchased in February 2004. Nearly all of the purchased assets are owned outright by subsidiaries of TOP CAT Holding Company LLC, a wholly-owned subsidiary of The Andersons, Inc., and are included in the balance sheet. These assets are included in a debt securitization that is non-recourse to the Company and looks solely to the securitized assets for collateral.
Item 3. Quantitative and Qualitative Disclosures about Market Risk
The market risk inherent in the Company’s market risk-sensitive instruments and positions is the potential loss arising from adverse changes in commodity prices and interest rates as discussed below.
Commodity Prices
The availability and price of agricultural commodities are subject to wide fluctuations due to unpredictable factors such as weather, plantings, government (domestic and foreign) farm programs and policies, changes in global demand created by population growth and higher standards of living, and global production of similar and competitive crops. To reduce price risk caused by market fluctuations, the Company follows a policy of hedging its inventories and related purchase and sale contracts. The instruments used are exchange-traded futures and options contracts that function as hedges. The market value of exchange-traded futures and options used for hedging has a high, but not perfect correlation, to the underlying market value of grain inventories and related purchase and sale contracts. The less correlated portion of inventory and purchase and sale contract market value (known as basis) is much less volatile than the overall market value of exchange-traded futures and tends to follow historical patterns. The Company manages this less volatile risk using its daily grain position report to constantly monitor its position relative to the price changes in the market. The Company’s accounting policy for its futures and options hedges, as well as the underlying inventory positions and purchase and sale contracts, is to mark them to the market price daily and include gains and losses in the statement of income in sales and merchandising revenues.
A sensitivity analysis has been prepared to estimate the Company’s exposure to market risk of its commodity position (exclusive of basis risk). The Company’s daily net commodity position consists of inventories, related purchase and sale contracts and exchange-traded contracts. The fair value of the position is a summation of the fair values calculated for each commodity by valuing each net position at quoted futures market prices. Market risk is estimated as the potential loss in fair value resulting from a hypothetical 10% adverse change in such prices. The result of this analysis, which may differ from actual results, is as follows:
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Interest Rates
The fair value of the Company’s long-term debt is estimated using quoted market prices or discounted future cash flows based on the Company’s current incremental borrowing rates for similar types of borrowing arrangements. In addition, the Company has derivative interest rate contracts recorded in its balance sheet at their fair values. The fair value of these contracts is estimated based on quoted market termination values. Market risk, which is estimated as the potential increase in fair value resulting from a hypothetical one-half percent decrease in interest rates, is summarized below:
Item 4. Controls and Procedures
The Company is organized with a Vice President, Controller and CIO who is responsible for all accounting and information technology decisions while our Vice President, Finance and Treasurer is responsible for all treasury functions and financing decisions. Each of them, along with the President and Chief Executive Officer (“Certifying Officers”), are responsible for evaluating our disclosure controls and procedures. These named Certifying Officers have evaluated our disclosure controls and procedures as defined in the rules of the Securities and Exchange Commission, as of September 30, 2004 and have determined that such controls and procedures were effective in ensuring that material information required to be disclosed by the Company in the reports filed under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms.
Our Certifying Officers are primarily responsible for the accuracy of the financial information that is presented in this report. To meet their responsibility for financial reporting, they have established internal controls and procedures which they believe are adequate to provide reasonable assurance that the Company’s assets are protected from loss. These procedures are reviewed by the Company’s internal auditors in order to monitor compliance. In addition, our Board of Director’s Audit Committee, which is composed entirely of independent directors, meets regularly with each of management and internal audit to review accounting, auditing and financial matters.
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There were no significant changes in internal controls or in other factors that could significantly affect internal controls during the third quarter of 2004. The Company has, however, continued to evaluate, refine procedures and enhance documentation around internal controls in preparation for management’s first annual report on internal controls as required by Section 404 of the Sarbanes-Oxley Act and the Securities and Exchange Commission for the year ended December 31, 2004.
Part II. Other Information
Item 1. Legal Proceedings
Investigators from the U.S. and Ohio Environmental Protection Agencies and the U. S. District Attorney’s office are looking into the purported possibility of an unauthorized discharge and/or a purported incident of failure to keep a record in connection with the purported discharge at the Company’s Maumee, Ohio, fertilizer plant. Management is cooperating with the investigation and, although the investigation could lead to formal proceedings, has no reason to believe that any outcome should materially affect the Company’s operations.
Item 6. Exhibits and Reports on Form 8-K
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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.
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Exhibit Index
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