Confidential
CARGILL, INCORPORATED
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
For the year ended May 31, 2007, compared with the year ended May 31, 2006
I. OVERVIEW…………………………………………………..….……………. 2 A. Corporate Organization B. Corporate Strategy
II. CONSOLIDATED REVIEW………………………………….….…….……. 3 A. Financial Performance B. Significant Developments C. Liquidity and Capital Resources
III. SEGMENT REVIEW...…………………………….……………………….… 10
IV. OTHER OPERATING MATTERS...…….…………..………….….……..… 19 A. Business Disposals B. CarVal Investors C. Asset Impairment Charges D. Litigation Summary
V. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS…....…...….. 21 A. Summary of Significant Accounting Policies B. New Accounting Pronouncements
This document may contain forward-looking statements that reflect management’s current view with respect to future results, achievements and financial performance. These statements may be identified by their use of forward-looking terminology such as “believes,” “expects,” “anticipates,” “may,” “will,” “should,” “seeks,” “approximates,” “suggests,” “intends,” “aims,” “plans,” “estimates,” or the negative of these words or other comparable terminology. Such forward-looking statements are subject to risks and uncertainties that may cause our actual results, achievements or performance to differ materially from those projected or implied. The most significant of these risks are described in this document. I. OVERVIEW
Cargill, Incorporated, headquartered in Minneapolis, Minn., is an international provider of food, agricultural and risk management products and services with 158,000 employees in 66 countries. Founded as a grain warehousing and merchandising company in 1865, Cargill today is one of the largest, privately owned companies in the world. We are committed to using our knowledge and experience to collaborate with customers to help them succeed.
A. Corporate Organization
Cargill reports results from operations in five segments: Agriculture Services, Origination and Processing, Food Ingredients and Applications, Risk Management and Financial, and Industrial. Our business units operate in four geographic regions: Asia Pacific, Europe/Africa, Latin America and North America.
B. Corporate Strategy
Cargill’s vision is to be the global leader in nourishing people. We carry out our vision by combining our knowledge and experience in food, agriculture and risk management to create solutions that help customers succeed. Cargill began executing our customer solutions strategy in fiscal 2000 and has since delivered six consecutive years of increased financial performance through fiscal 2007.
2 Confidential II. CONSOLIDATED REVIEW
A. Financial Performance
Reclassification: Certain fiscal 2006 amounts in this report were reclassified to conform with the current year presentation.
Consolidated summary of quarterly financial results Three months ended
May 31, May 31, Percent Dollars in millions 2007 2006 change Net earnings $ 628 $ 168 274 Sales and other revenues $ 24,311 $ 19,768 23
Fourth quarter: Cargill earned $628 million in the fiscal 2007 fourth quarter, compared with $168 million in the same period a year ago. Last year’s fourth-quarter results included a one-time $190 million noncash charge to Cargill’s net earnings that was the company’s share of a restructuring charge taken by The Mosaic Company related to its phosphate fertilizer business. Excluding the charge, Cargill earned $358 million in the 2006 fourth quarter.
Fourth-quarter earnings in all five segments increased from a year ago. Nearly 60 percent of the business units exceeded last year’s fourth-quarter results, producing the strong performance.
Fourth-quarter revenues reached $24.3 billion, up $4.5 billion or 23 percent, from the same period a year ago.
3 Confidential
Consolidated summary of financial results 12 months ended May 31, May 31, May 31, Dollars in millions 2007 2006 2005 Earnings from continuing operations $ 2,343 $ 1,537 $ 2,070 Earnings from discontinued operations -- -- 81 Cumulative effect of accounting change -- -- (48) Net earnings $ 2,343 $ 1,537 $ 2,103 Net earnings, excluding special items related to Mosaic $ 2,343 $ 1,727 $ 1,525 Sales and other revenues $ 88,266 $ 75,208 $ 71,066 Cash flow from continuing operations 3,965 3,318 3,196 Capital investments 2,386 3,047 2,008
Full year: For the fiscal 2007 year, Cargill earned $2.34 billion. Fiscal 2006 earnings of $1.54 billion included a one-time $190 million noncash charge to Cargill’s net earnings that was the company’s share of a restructuring charge taken by The Mosaic Company related to its phosphate fertilizer business. Excluding the charge, Cargill earned $1.73 billion in fiscal 2006. Fiscal 2005 earnings of $2.1 billion also included a special item: a $578 million noncash net gain related to the formation of The Mosaic Company.
Among the company’s five segments, three delivered record earnings: Risk Management and Financial, Origination and Processing, and Industrial. Results in Food Ingredients and Applications were ahead of last year. Earnings in Agriculture Services nearly matched last year’s record results.
Revenues for the full year rose 17 percent to $88.3 billion, an increase of $13.1 billion. The improvement was broad based, with all five segments reporting increased revenues for the year.
4 Confidential B. Significant Developments
1. Acquisitions and alliances completed
No significant business investments were completed in the fourth quarter of fiscal 2007.
The following investments were completed in the third quarter of fiscal 2007: • On Jan. 19, 2007, Cargill purchased LNB International Feed, a Dutch manufacturer and exporter of animal nutrition products. LNB specializes in mineral- and vitamin- based premix products, which complement Cargill Animal Nutrition’s larger global presence in the feed concentrate and complete feed segments. The acquisition also takes CAN into Russia and Romania, two key markets for future growth. • On Dec. 20, 2006, Cargill acquired a soybean crush plant in Yangjiang, China, in the southern province of Guangdong, a large soybean meal and vegetable oil consuming region. Cargill also acquired a 49 percent share of a port operation adjacent to the crush plant.
The following investments were completed in the second quarter of fiscal 2007: • On Sept. 6, 2006, Cargill acquired a one-third stake in RightShip, an Australian- headquartered ship vetting company. Through RightShip, Cargill and our partners, BHP Billiton and Rio Tinto, expect to have the capability to improve global shipping standards in dry bulk ocean freight. • On Sept. 25, 2006, Horizon Milling G.P, a new partnership between Cargill and CHS (Cenex Harvest States), purchased The J.M. Smucker Company’s Canadian grain-based food service and industrial businesses. The acquisition included milling and mixing operations in three provinces, a research and development center, a licensing agreement to produce the Robin Hood® brand for food service and industrial markets, and a supply agreement to provide branded retail baking products, such as Robin Hood® flour, to Smucker for sale at retail. CHS participated in the purchase at the same 24 percent ownership share it has in U.S.-based Horizon Milling, LLC. • On Nov. 3, 2006, Cargill Animal Nutrition acquired certain assets of Eagle Milling’s feed milling and pet and animal wholesale products business based in Casa Grande, Ariz. The acquisition should open growth opportunities in the Arizona marketplace.
The following investments were completed in the first quarter of fiscal 2007: • On June 12, 2006, Cargill purchased a majority of the shares of a sugar cane mill and distillery in Patrocinia Paulista, São Paulo state, Brazil. Cargill owns almost 63 percent of the shares, with the balance owned by Canagril, a growers’ association that supplies 100 percent of the cane to the mill. The mill converts sugar cane to ethanol. The investment is Cargill’s first step toward gaining a presence in the Brazilian sugar cane milling and ethanol industry. • On July 25, 2006, Cargill entered into a sugar processing joint venture with Russkiy Sakhar, a Russian sugar company that owns two sugar mills. Through the joint venture, Cargill purchased a 25 percent share in Russkiy Sakhar’s
5 Confidential Nikiforovsky facility, a major beet and raw sugar processing plant located in the Tambov region in central Russia. The minority stake should enable Cargill to gain experience in sugar processing in Russia. • On Aug. 7, 2006, Cargill acquired its joint venture partner’s share of a xanthan gum production facility in Zibo in China’s coastal province of Shandong. The joint venture, Cargill Huanghelong Bioengineering, was formed in April 2003. It is now part of the Cargill Texturizing Solutions business unit.
The following acquisitions were completed in the first quarter of fiscal 2008: • Cargill purchased nine grain elevators and an export terminal in Canada from Saskatchewan Wheat Pool. The transaction, which included an exchange of assets in addition to cash, was completed on June 29, 2007.
2. Acquisitions and alliances announced
On July 10, 2007, Cargill announced its intention to increase its ownership of Agrograin, a Hungarian grain company, to 100 percent from 35 percent. The acquisition enlarges Cargill’s grain origination capacity in Central and Eastern Europe. The deal is subject to regulatory and other approvals.
6 Confidential C. Liquidity and Capital Resources
Consolidated summary of cash flow May 31, May 31, May 31, Dollars in millions 2007 2006 2005 Cash flow from continuing operations $ 3,965 $ 3,318 $ 3,196 Cash flow from discontinued operations -- -- 413 Total cash flow $ 3,965 $ 3,318 $ 3,609 Capital investments: Property additions $ 1,970 $ 1,863 $ 1,447 Business acquisitions, less cash received 210 1,021 280 Investments in nonconsolidated companies and purchase of minority interests 206 163 281 Total capital investments $ 2,386 $ 3,047 $ 2,008
1. Cash flow
Cash flow from continuing operations totaled $3.97 billion in fiscal 2007, an increase of $647 million or 19 percent from a year ago. The increase is a reflection of the company’s improved profitability.
In fiscal 2005, cash flow from discontinued operations was $413 million. This included earnings generated by the operation of North Star Steel’s remaining steel assets prior to their sale to Gerdau Ameristeel on Nov. 1, 2004, and the proceeds from that sale.
2. Capital investments
In fiscal 2007, Cargill reinvested a majority of its cash flow in food ingredient and supply chain capabilities aimed at better serving customers in food, agriculture and risk management.
Business acquisitions, less cash received, were $210 million in fiscal 2007. Acquisitions and investments completed in the current period are discussed in Section II.B.1.
Property additions equaled $1.97 billion in fiscal 2007. Of that, base level spending totaled $515 million, excluding the fertilizer business. These are expenditures that maintain or enhance existing capacity and facilities. They reflect Cargill’s commitment to maintaining the company’s core assets and safety and environmental standards.
In fiscal 2006, business acquisitions, less cash received, were $1 billion. The larger acquisitions included Degussa’s food ingredients operations, palm plantations in Indonesia and Papua New Guinea, a small industrial chocolate facility in eastern Germany, a provider of bakery product development services and premixes near Portland, Ore., a sunflower seed crush plant in Kahovka, Ukraine, Canadian-based beef processing operations, and a group of California-based meat processors.
7 Confidential
3. Debt
The company’s consolidated debt is made up of the debt of closely owned businesses and of The Mosaic Company, a publicly traded company in which Cargill is the majority shareholder. Cargill total consolidated debt was $19.3 billion as of May 31, 2007, an increase of 1 percent from Feb. 28, 2007.
As part of its ongoing term debt issuance program, Cargill completed a 30-year £150 million debt offering in March 2007. A 10-year €500 million debt issuance was completed in May 2007. Proceeds from these transactions were used to replace maturing debt and for general corporate purposes.
Summary of debt May 31, Feb. 28, Increase Percent Dollars in millions 2007 2007 (decrease) change Cargill debt excluding Mosaic: Recourse debt: Short-term $ 7,189 $ 7,852 $ (663) (8) Long-term 7,557 6,961 596 9 Total recourse debt $ 14,746 $ 14,813 $ (67) -- Nonrecourse debt from VIEs: Short-term $ 583 $ 366 $ 217 59 Long-term 1,660 1,451 209 14 Total nonrecourse debt $ 2,243 $ 1,817 $ 426 23
Cargill debt excluding Mosaic $ 16,989 $ 16,630 $ 359 2
Mosaic debt: Nonrecourse to Cargill, Inc. 2,340 2,552 (212) (8) Other debt 14 14 -- -- Total Mosaic debt 2,354 2,566 (212) (8) Cargill consolidated debt 19,343 19,196 147 1
Interest expense on short-term debt increased from a year ago by $175 million, or 62 percent, to $459 million for the year. The increase reflected a rise in short-term interest rates and average short-term debt outstanding during the year. Interest expense on long- term debt increased by $73 million, or 12 percent, to $686 million for fiscal 2007. In fiscal 2007, interest expense for nonrecourse debt totaled $110 million, excluding Mosaic. Total interest expense on debt for The Mosaic Company was $185 million.
8 Confidential Cargill’s syndicated committed credit facility was $4 billion on May 31, 2007. It is structured as a revolving line of credit, consisting of a $1.25 billion, 364-day facility and a $2.75 billion, 5-year facility. On May 31, 2007, the syndicated facility was supplemented by $840 million of committed bilateral lines. These credit facilities provide backup liquidity to the company’s commercial paper programs.
4. Credit rating
Cargill’s credit rating summary at May 31, 2007 Agency Long- Short- term term rating rating Standard & Poor’s A A-1 Moody’s Investors Service A2 P-1
Fitch Ratings A F1
Dominion Bond Rating Service (DBRS) A (high) R-1 (middle)
9 Confidential III. SEGMENT REVIEW
Reclassification: Certain fiscal 2006 amounts in this section were reclassified to conform with the current year presentation.
Summary of earnings from continuing operations by segment (excluding special items related to The Mosaic Company) May 31, May 31, May 31, Dollars in millions 2007 2006 2005 Agriculture Services $ 129.9 $ 131.3 $ 128.1 Origination and Processing 514.7 458.5 418.4 Food Ingredients and Applications 470.3 291.6 456.2 Risk Management and Financial 797.7 692.7 521.0 Industrial 368.7 183.1 224.0 Corporate and Other 62.0 (30.5) (255.9) Total $ 2,343.3 $ 1,726.7 $ 1,491.8
Earnings from continuing operations by segment
2,500 Agriculture Services 2,000 Origination and Processing 1,500 Food Ingredients and Applications Risk Management and Financial 1,000
Industrial 500
Corporate/Other 0
(500) (Dollars in millions) 2007 2006 2005
Summary of sales and other revenues to unaffiliated customers by segment May 31, May 31, May 31, Dollars in millions 2007 2006 2005 Agriculture Services $ 7,160.6 $ 5,989.2 $ 6,498.4 Origination and Processing 30,303.7 24,486.3 23,516.3 Food Ingredients and Applications 38,822.7 34,679.5 32,350.1 Risk Management and Financial 4,983.7 3,759.0 3,435.0 Industrial 6,611.9 6,061.1 5,100.5 Corporate and Other 383.7 232.8 165.9 Total $ 88,266.3 $ 75,207.9 $ 71,066.2
10 Confidential A. Agriculture Services
Segment Description Earnings Earnings Percent Performance
130 131 128 Agriculture Services provides 6% crop and livestock producers worldwide with customized farm services and products.
2007 2006 2005
Segment earnings were $129.9 million in fiscal 2007, a decrease of one percent from the prior year. Revenues exceeded the level of the prior year by $1.2 billion or 20 percent.
Operating in a challenging environment, Cargill Animal Nutrition remained a top contributor to company earnings, although slightly below last year’s strong performance. Rising commodity costs narrowed gross margins and tempered overall results. LNB International Feed, which was acquired in the third quarter, was accretive to earnings.
Higher commodity prices benefited the Cargill AgHorizons businesses in North America. For the U.S. spring planting season, crop inputs sales increased in response to higher grain prices. Margins also widened on a larger volume of grain handled and stored. In the United States, earnings strengthened in the fourth quarter, although annual results were somewhat below last year’s record performance. The business in Canada positioned product early to capitalize on the crop inputs demand spurred by higher prices for corn and canola. Increased availability of grain for export also contributed to results. The business realized its best quarter ever.
Frontier Agriculture Limited, the U.K. joint venture, also benefited from crop inputs sales and strong grain margins.
During the fourth quarter, the Renessen Feed and Processing joint venture announced that commercial operations in Argentina would be discontinued to focus exclusively on the development and commercialization of the Extrax™ corn processing system. The narrower focus requires a smaller organization and infrastructure. As a result, asset impairment and restructuring charges were incurred in the fourth quarter, which brought fiscal 2007 results slightly below last year.
11 Confidential
B. Origination and Processing
Segment Description Earnings Earnings Percent Performance
515 459 418 Origination and Processing 22% connects producers and users of grain, oilseeds and other agricultural commodities through origination, processing, marketing and distribution services. 2007 2006 2005
Segment earnings rose to a record $514.7 million, a $56.2 million or 12 percent increase over last year’s results. The segment’s emphasis on global coordination of information, market analysis and risk management has resulted in six years of strong returns. Fiscal 2007 net revenues rose $5.8 billion or 24 percent.
The Cargill Grain & Oilseed Supply Chain posted record earnings in fiscal 2007. Global interest in biofuels and growth of investment fund participation in agricultural commodities markets created volatile operating conditions. In addition, congested conditions at many ports tightened ocean fleet capacity utilization and returned freight rates to record levels.
The impact of unexpectedly large supplies of sucrose from Brazil entering the world market and China and India’s eventual failure to import forecasted supplies led to trading losses in Cargill Sugar.
For the first time ever, Cargill Cotton ended the year with a moderate loss, which reflected a challenging period characterized by weak global demand. Operations in Africa also were hurt by the unstable political and economic environment in Zimbabwe.
12 Confidential C. Food Ingredients and Applications
Segment Description Earnings Earnings Percent Performance
470 456 Food Ingredients and Applications serves food makers, 292 food service companies and retailers with food and beverage ingredients, meat and poultry 20% products, and new food 2007 2006 2005 applications.
Segment earnings grew $178.7 million or 61 percent from the previous year’s results, with a majority of businesses delivering improved results over last year. Revenues increased by $4.1 billion or 12 percent in fiscal 2007.
1. Food ingredients
In fiscal 2007, the North American and European food businesses increased earnings significantly from last year. Several of the European businesses overcame high raw material and energy costs in order to post improved performances.
Strong results in Cargill Corn Milling North America were driven by its ethanol, feed, risk management and corn oil product lines. Although sweetener earnings strengthened in the fourth quarter, annual results were below expectations due to back-order positions early in the fiscal year.
Benefited by its multi-year effort to build a leadership position in trans fat solutions, Cargill Dressings, Sauces & Oils realized higher margins on increased sales of specialty oils blends. Trading gains on tropical, peanut and cottonseed oils added to the record earnings for the year.
Horizon Milling posted solid results from good sales volumes, flour margins and processing yields. Additionally, volatile grain markets allowed the business to take advantage of merchandising opportunities.
Cargill Specialty Canola Oils benefited from increased demand for canola oil and seed due to food companies’ emphasis on reducing trans fatty acids in food products. As a result, the business generated a profit for the first time in fiscal 2007.
A strong Brazilian currency rate, and high energy and raw material cost negatively impacted Cargill Acidulants’ ability to export citric acid from its facility in that country. A significant
13 Confidential asset impairment charge was recorded as a result. High corn and energy costs also affected operations adversely in North America.
Solid margins and shipments in cocoa processing generated strong earnings in Cargill Cocoa & Chocolate for the year. Higher costs and lower volumes in the chocolate product line tempered results somewhat and brought overall earnings below last year’s robust results.
Cargill Sweeteners Europe negotiated higher sales prices for calendar 2007, which compensated for the prior year’s poor wheat crop that drove up raw material costs in the first half of the 2007 fiscal year. Anticipating additional raw material increases in calendar 2007, forward purchases were locked in early, which helped mitigate the impact.
Products supplied to the paper, corrugating and bio-chemical industries generated strong volumes and excellent margins, which contributed to record earnings in Cargill Industrial Starches in fiscal 2007. Higher raw material and energy costs were offset by increased sales prices.
The foods businesses in Russia were hurt by expensive raw material and energy costs. Although syrup and starch prices strengthened, the late start-up of its new vegetable oil refinery in Efremov delayed anticipated shipments of edible oil product. Low sales volume and high barley costs from the poor 2006 crop hurt results in malt.
Although one of the Latin American food businesses delivered a record performance, results for the five business units in total were below last year.
Cargill Starches & Sweeteners Brazil posted record earnings. Corn grind at the Uberlândia plant reached a record high to fulfill strong sales volumes. The tapioca business also was strong, although it contended with competitive pressures.
Good flour volumes and margins in Argentina generated solid results for Cargill Flour Mercosur. However, a bad debt charge, larger inventory levels and an unfavorable currency exchange rate led to large losses in Brazil.
Due to a large loss in Cargill Refined Oils India, the Asian-based food businesses realized a small loss collectively. The oils unit was hurt by high import tariffs and excess industry capacity. Cargill's food distribution business in Japan delivered improved earnings due to strong beverage products profits, good corn trading margins and strong cocoa bean sales.
2. Meat products
Cargill Meat Solutions matched last year’s results.
Cargill Value Added Meats increased earnings in fiscal 2007. Although margins began to reflect the impact of higher corn costs in the fourth quarter, the balance of the year was characterized by solid margins and volumes, and operational efficiencies.
14 Confidential Cargill Case Ready delivered strong earnings by focusing on customer service and adding new customers to the portfolio. Increased volume and improved operating efficiencies also enhanced results.
Cargill Beef earnings for fiscal 2007 improved over last year. However, tight cattle supplies and rising grain costs produced higher cattle costs and smaller cattle feeding margins in the fourth quarter. Operating in the tough beef environment, Cargill Food Distribution generated strong revenues and volumes. Cargill Regional Beef benefited from a steadier supply of culled dairy cattle and good demand for ground beef.
Margins narrowed for Cargill Pork’s live hog production, as live hog selling prices did not rise as quickly as corn costs. Export and U.S. retail demand for pork also softened.
Drought conditions in Australia hurt the beef processing business there. Beef sales prices were insufficient to cover the impact of tight supplies of high-priced cattle.
3. Food service and retail products
Results for the businesses in this group fell well below last year due to the difficulties in meat and poultry processing operations in Brazil and Thailand.
Seara, the Brazilian poultry and pork processor, incurred large losses throughout the year due to Russia’s continued restrictions on Brazilian pork imports, high corn costs and a strong Brazilian currency exchange rate.
The lingering threat of avian influenza weakened Sun Valley’s margins and earnings in fiscal 2007. A strong baht currency exchange rate and start-up costs related to its new processing plant also contributed to the downturn.
Sales price increases in the chicken retail sector offset rising feed grain costs and lifted earnings in Sun Valley Europe slightly above last year.
Since its inception six years ago, Sun Valley Foods Canada has increased profitability every year. Investment in automated processes delivered cost efficiencies for the business.
Improved poultry sales volumes and prices enabled Sun Valley Central America to increase earnings over last year.
Sunny Fresh Foods continued to help customers shift to higher value items. Although margins narrowed in the fourth quarter due to higher commodity prices that impacted the shell egg market, Sunny Fresh delivered its 12th consecutive year of improved profits.
4. Food system design
All but one of the businesses in this group improved over last year. Results in Cargill Sweetness Solutions fell below last year.
15 Confidential A moderate loss in Cargill Sweetness Solutions was due to higher raw material and energy costs, and competitive pressures.
Facing a competitive environment, Cargill Flavor Systems struggled to gain sales volumes in Europe. In addition to flavors applications, the juice segment offers juice-based beverage bases and applications; over the past year, certain juices have experienced tight supplies and record-high prices that also pressured margins.
Significantly higher raw material and energy costs hurt results in Cargill Texturizing Solutions but its loss was less than last year. Calendar 2007 price increases for starch products were not sufficient to cover the shortfall.
Operating performance in Cargill Health & Food Technologies benefited from strong results in arachidonic acid, an essential fatty acid that, in conjunction with DHA, an omega-3 essential fatty acid, is recognized as important in infant nutrition. The business secured a significant settlement when a minority joint venture partner in a production facility decided to exit the partnership and renegotiate its long-term supply agreement with H&FT.
Although volumes were lower and raw materials costs higher, the focus on customer solutions improved margins in Cargill Cocoa & Chocolate North America. Earnings were nearly double last year’s results. A liquor plant expansion was completed and processing began in the fourth quarter; initial yields for liquor and fat exceeded target.
Cargill Juice North America faced a difficult environment due to declining demand for 100 percent juices, recent years’ hurricanes that damaged citrus crops and the loss of groves due to real estate development. Cargill announced plans to permanently cease operations in the Florida cities of Frostproof and Avon Park. The business will continue to fulfill existing obligations to customers.
16 Confidential D. Risk Management and Financial
Segment Description Earnings Earnings Percent Performance
798 693
Risk Management and Financial 521 provides customers and Cargill with risk management and 34% financial solutions in world markets. 2007 2006 2005
Segment earnings increased $105 million, or 15 percent, from the prior year. The diverse businesses in this segment posted its fifth consecutive year of earnings growth.
CarVal Investors delivered its eighth consecutive year of record earnings. Investments in corporate securities of companies undergoing reorganization or bankruptcy, particularly the energy and aviation industries, contributed substantial earnings. Profits from real estate asset sales in Japan and Europe, and collections in the consumer, residential and commercial loan portfolios also enhanced results.
Funds managed by Black River Asset Management grew substantially, with $9.5 billion of assets under management on May 31, 2007. Returns from Cargill’s fund investments met expectations.
Earnings in Cargill Ferrous International matched last year. Tight management of the steel service centers’ inventory in the first half, when industry inventories were high, positioned the business to take advantage of recovering margins in the fourth quarter. Its trading activities capitalized on trade flows and global fluctuations in steel scrap prices.
Record earnings in Cargill Petroleum were bolstered by its petroleum group, which captured geographic, time and inter-product spreads. Its European gas and power group also generated strong trading margins.
Cargill Coal posted record earnings for the year as it continued to expand its geographic coverage. Physical trade in South Africa was the largest contributor to results. Trading activities benefited from strong global coal markets.
In Cargill Power & Gas Markets, the power business generated strong earnings for the year, driven by solid execution related to owned transmission, hourly trading and position management in weather markets. The natural gas business realized sizable losses from relative value spread positions taken early in the year and the lack of liquidity associated with managing out of those positions. Overall, the business ended with a slight loss.
17 Confidential E. Industrial
Segment Description Earnings Earnings Percent Performance 369
The Industrial segment 16% 224 supplies customers with 183 fertilizer, salt, steel and industrial uses for agricultural feedstocks. 2007 2006 2005
Segment earnings increased by $185.6 million to $368.7 million for the year, largely due to improved earnings in The Mosaic Company.
In its sixth consecutive year of improved results, Cargill Salt posted record earnings. Significant price increases in nonseasonal products more than offset the negative impact of weaker sales of weather-dependent products during a mild winter. Improved profitability at vacuum evaporation facilities resulted in a significant increase in the depletion tax credit. The mild winter also impacted earnings negatively in Cargill Deicing Technology, which were moderately below last year. Mine production was reduced in response to lower demand.
Despite higher raw material costs, strong demand for steel products generated higher volumes and lifted earnings in the steel joint venture.
Demand for NatureWorks’ products rose, which increased revenues and decreased losses somewhat compared with last year. However, poorer-than-expected product yields and higher raw material and energy costs kept results below expectations.
Earnings in The Mosaic Company increased in fiscal 2007. The fiscal 2006 segment earnings shown above exclude a charge taken by The Mosaic Company related to the restructuring of its phosphate fertilizer business.
F. Corporate and Other
As discussed in the prior quarter, the significant improvement in Corporate and Other is due primarily to a decrease in income tax-related expenses, which resulted primarily from resolution of open income tax issues.
18 Confidential IV. OTHER OPERATING MATTERS
A. Business Disposals
Cargill did not have any significant business disposals in fiscal 2007. Business disposals during 2006 included the sale of Cargill Investor Services, a commodity brokerage business. Proceeds from the 2006 disposals were $184 million with gains of $34 million, net of tax.
B. CarVal Investors
As noted in Section V.A.6., in fiscal 2007, CarVal Investors closed on the funding of CVI Global Value Fund, a fund formed to invest in loan portfolios, real estate, corporate securities and special opportunities. Subscriptions accepted by the fund totaled more than $5.75 billion. Cargill owns an interest of approximately 38 percent in the fund. The fund’s remaining investors include more than 75 institutional investors consisting of pension plans, endowments, foundations and trusts.
C. Asset Impairment Charges
Cargill periodically evaluates the carrying value of long-lived assets, including goodwill and other intangible assets, when events and circumstances indicate the carrying value may not be recoverable. If the carrying value of a long-lived asset is considered impaired, a loss is recognized based on the amount by which the carrying value exceeds the fair market value. Impairments during fiscal 2007 included food processing assets in Brazil, the United States and Europe. Major impairments in fiscal 2006 consisted primarily of $284 million for fertilizer assets in the United States, which equals $190 million, Cargill share after tax and minority interest, and of food processing assets in India and Europe. Restructuring charges also were recorded to cover exit and employee severance costs related both to assets to be sold and assets to be held and used. In 2007, asset impairment charges totaled $60 million after tax, and, in 2006, were $433 million after tax.
D. Litigation Summary
In July and August 2000, an outbreak of E. coli 0157:H7 occurred in two Sizzler chain restaurants in the Milwaukee, Wisc., area. According to a report issued by the state of Wisconsin, more than 60 confirmed cases of E. coli 0157:H7 illnesses and the death of one child are linked to the outbreak. Cargill Meat Solutions, through distributor Sysco Services of Eastern Wisconsin, was a supplier of meat products to the two Milwaukee Sizzler restaurants. It was alleged that an unopened CMS sirloin tri-tip product taken from one of the restaurants tested positive for the same strain of E. coli as that found in the affected patrons. One consumer lawsuit remains pending in state court against CMS, relating to the death that was linked to the outbreak. Since the onset of this litigation, several consumer lawsuits against CMS have been settled, while several others have been dismissed. In January 2002, Sizzler USA Franchise, Inc., filed a third-party complaint against Cargill and a cross claim against CMS in state court for damages. In May 2002, CMS prevailed on a
19 Confidential motion for summary judgment and the state trial court dismissed the plaintiffs’ claims and the cross claim by Sizzler against CMS. The Wisconsin Court of Appeals reversed the trial court’s summary judgment in favor of CMS. The Wisconsin Supreme Court declined to hear the case. On March 22, 2004, the U.S. Supreme Court declined to hear a certiorari petition filed by CMS asking it to hear the appeal. While the consumer lawsuit and Sizzler’s cross claim against CMS remain pending, Sizzler’s third-party complaint against Cargill has been dismissed. E&B Management Co. of Waukesha, the Sizzler franchisee that operated the two Sizzler restaurants in Milwaukee, along with E&B’s insurer (Secura Insurance, a Mutual Company), also recently filed a cross-claim and a direct lawsuit against CMS, under a Guaranty provided by CMS to Sysco, on the grounds that E&B was a third-party beneficiary of the Guaranty. The judge did not dismiss E&B’s claims based on the statute of limitations or claim preclusion. Trial will be deferred to 2008.
On June 18, 2005, the State of Oklahoma filed a water quality lawsuit against Cargill and other poultry integrators in the U. S. District Court for the Northern District of Oklahoma, related to alleged nutrient loading in certain Oklahoma and western Arkansas watersheds. Specifically, the lawsuit seeks damages and injunctive relief based upon the alleged adverse environmental impact of excess nutrients associated with the land application of poultry litter by the companies and contract growers. The parties were unsuccessful in mediating the claims. Answers from Cargill and the other defendants were filed in October 2005. We are preparing experts and other discovery plans. In March 2007, the court set a comprehensive case management order, which estimates that trial will take place in January 2009. Discovery to date has been mired in delays and motion practice, and the parties are also submitting various motions to dismiss, strike, stay or sever third party claims.
The outcome of any litigation is not predictable with certainty, or subject to the company’s control. However, it is the opinion of management that any ultimate liability in any known litigation against the company has been provided for, or will not have a material adverse effect on our consolidated financial condition, cash flows or results of operations.
20 Confidential V. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The following is a summary of key accounting policies and disclosures. For further information, refer to the audited consolidated financial statements and footnotes for the year ended May 31, 2007.
A. Summary of Significant Accounting Policies
Significant accounting policies followed in preparing the consolidated financial statements are summarized below.
1. Nature of Business
The Company is engaged in the international marketing and processing of agricultural, industrial and financial commodities. Operating in 66 countries worldwide, the Company markets its products principally in four geographic regions: Asia/Pacific, Europe/Africa, Latin America and North America.
2. Basis of Consolidation
The accompanying consolidated financial statements include the accounts of Cargill, Incorporated and all entities that we control by ownership of a majority voting interest as well as certain variable interest entities, where the Company is the primary beneficiary. Intercompany accounts and transactions are eliminated. Investments in companies where the Company does not have control, but has the ability to exercise significant influence (generally 20 percent to 50 percent ownership), are accounted for by the equity method. Net earnings include the Company’s share of net income in these companies. Other investments where the Company is unable to exercise significant influence over operating and financial decisions are accounted for at cost.
3. Variable Interest Entities
The FASB issued Interpretation No. 46 (revised December 2003), “Consolidation of Variable Interest Entities” (FIN 46R), which requires certain variable interest entities (VIEs) to be consolidated. FIN 46R separates entities into two groups: (1) those for which voting interests are used to determine consolidation and (2) those for which variable interests are used to determine consolidation. An entity is considered to be a VIE when it has equity investors who lack the characteristics of a controlling financial interest, or the entity’s capital is insufficient to permit it to finance its activities without additional subordinated financial support. A VIE is consolidated by its primary beneficiary, which is the company that absorbs a majority of the VIE's expected losses, receives a majority of the VIE’s expected residual returns, or both. Entities not considered to be a VIE are evaluated for consolidation under the voting control model.
In the accompanying consolidated financial statements, the Company has applied FIN 46R to all entities. The consolidated VIEs include partnerships, LLCs, corporations and trusts that acquire, hold, restructure and dispose of performing and nonperforming loans and real estate
21 Confidential assets as well as a few food businesses, power plants and synthetic lease structures. Consolidated VIEs are funded by a combination of equity and third party nonrecourse debt. The equity interests of consolidated VIEs not owned by the Company are reported as Minority Interests in Subsidiaries on the Company’s consolidated balance sheet.
The Company also holds variable interests in the form of loan and equity investments in a variety of VIEs for which the Company is not the primary beneficiary. These VIEs primarily hold, restructure and dispose of performing and nonperforming loans and real estate assets.
4. 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 amounts reported in the financial statements and accompanying notes. Although these estimates are based on knowledge of current events and actions expected to be undertaken in the future, actual results may ultimately differ from estimates.
5. Revenue Recognition
The Company recognizes revenue from commodity or product sales when the goods are shipped or delivered depending upon when the customer has taken title and assumed the risks and rewards of ownership, prices are fixed or determinable and collectibility is reasonably assured. Additional revenue recognition policies for trading securities and derivatives and inventories are shown below.
6. Affiliated Private Investment Funds
The Company’s noncontrolling investment in several affiliated private investment funds is included in the “investments and advances” line on the consolidated balance sheet. These affiliated private investment companies use investment company accounting and report all assets and liabilities at fair value. Investment company accounting has been retained by the Company for its investments in the funds and accordingly, the Company’s share of each fund’s earnings is included in the determination of net earnings.
The Company’s subsidiary, Black River Asset Management LLC is a global asset management company that has developed and marketed a number of affiliated private investment funds, under the Black River name, with differing types of investment strategies. Black River provides investment advisory services for these funds and for certain proprietary accounts for the Company.
During 2007, the Company restructured its value investment business into CarVal Investors, LLC (CarVal), a Cargill subsidiary. CarVal formed the CVI Global Value Fund (CVI Fund) to provide institutional investors with a variety of value investments including loan portfolios, corporate securities, real estate and special opportunities. CarVal provides investment advisory services to the CVI Fund and for certain proprietary accounts for the Company.
22 Confidential 7. Foreign Currency Translation
Gains and losses resulting from translating the financial statements of foreign subsidiaries, whose functional currency is the local currency, at the current rate are included directly in other comprehensive income.
Translation gains and losses of foreign subsidiaries operating in hyperinflationary economies and foreign subsidiaries where the U.S. dollar is the functional currency are included in net earnings currently.
8. Cash and Cash Equivalents
Cash equivalents consist of short-term, highly liquid investments with original maturities of 90 days or less.
9. Short-term Investments
Short-term investments include highly liquid investments with original maturities greater than 90 days, but less than one year.
10. Asset Retirement Obligation
The Company incurs obligations related to the retirement of certain long-lived assets. The fair values of these retirement obligations are recorded as liabilities on a discounted basis at the time the obligations are incurred. Upon recognition of the liability, the cost is capitalized as part of the related long-lived asset and depreciated over the estimated useful life of the related asset. Accretion expense in connection with the discounted liability also is recognized over the estimated useful life of the related asset.
11. Resale and Repurchase Agreements
Financial instruments purchased with agreements to resell (reverse repurchase agreements) and financial instruments sold with agreements to repurchase (repurchase agreements) are treated as collateralized financing transactions and are recorded at the amount at which the financial instruments were initially acquired or sold, including accrued interest. Interest income is recorded on reverse repurchase agreements and interest expense is recorded on repurchase agreements.
It is the Company’s policy to take delivery of financial instruments purchased with agreements to resell, which are generally U.S. government or U.S. government agency securities. The Company has the ability to sell or re-pledge the securities. The Company monitors the market value of the financial instruments to be resold daily and obtains additional collateral when deemed appropriate. The collateral for financial instruments sold with agreements to repurchase consists of securities, other assets, accounts receivable and notes receivable. The Company offsets resale and repurchase agreements that meet the applicable netting criteria.
23 Confidential 12. Trading Securities and Derivatives
The Company is engaged in the leveraged trading of a diverse group of securities and, accordingly, its trading securities and trading securities sold, not yet purchased are recorded on trade date at fair value. These instruments are marked to market with realized and unrealized gains and losses included in the determination of net earnings. Interest on trading securities sold, not yet purchased is netted against interest income and shown as “sales and other revenues” in the consolidated statement of earnings.
Derivative instruments, including swaps, futures contracts, forward commitments, options and other similar types of contracts and commitments based on either interest rates or foreign exchange rates, as well as equity and commodity derivatives, are traded by the Company and are carried at their fair market value as either trading securities or trading securities sold, not yet purchased. The fair market value of almost all trading securities and derivatives, as described above, is determined from market prices quoted on public exchanges or based on management’s best estimate subject to independent price verification. New complex instruments may have immature or limited markets. As a result, the pricing models used for valuation may require significant estimates and assumptions. An insignificant amount of positions are valued in this manner.
In addition to its trading activities, the Company utilizes various types of derivative instruments (principally options, futures and interest rate and currency swaps) to hedge interest rate, currency and other market risks arising from certain of its assets and liabilities. The Company values its derivative instruments in accordance with SFAS 133, "Accounting for Derivative Instruments and Hedging Activities" as amended. The statement requires that all derivative instruments be recognized in the balance sheet at fair value with changes in such fair values recognized immediately in earnings unless specific hedging criteria are met. Effective changes in the fair value of derivatives designated as cash flow hedges and net foreign currency investment hedges are recorded in accumulated other comprehensive income. Amounts are reclassified from accumulated other comprehensive income when the underlying hedged item impacts net earnings and all ineffective changes in fair value are recorded currently in net earnings. Changes in the fair value of derivatives designated and effective as fair value hedges are recorded in earnings and are offset by corresponding changes in the fair value of the hedged item.
13. Inventories
Grain, cotton and other commodities for merchandising and oilseeds and other commodities for processing and products thereof are stated principally at market, adjusted for unrealized gains or losses on open cash contracts valued at market. Market is determined from market prices quoted on public commodity exchanges, adjusted for expected freight costs to normal delivery points and a price premium or discount to cover local supply and demand factors as estimated by management. The availability and market price of agricultural commodities are subject to wide fluctuations due to unpredictable factors such as weather, plantings, domestic and foreign government farm programs and policies, global production and other factors. The Company generally minimizes the risk of market fluctuations by hedging these inventories with futures,
24 Confidential cash, and foreign exchange contracts. Generally these contracts are valued at market and the resulting unrealized gains or losses are recognized currently in earnings. Dressed beef, poultry, salt and other products are valued at the lower of cost (last-in, first-out) or market. All other inventories are stated principally at the lower of cost or market.
14. Property, Plant and Equipment
Property, plant and equipment are stated at cost and depreciated principally using the straight- line method over the estimated useful lives of the assets. The company periodically evaluates the carrying value of these long-lived assets when events and circumstances indicate the carrying value may not be recoverable. If the carrying value is considered impaired, a loss is recognized based on the amount by which the carrying value exceeds fair market value.
15. Income Taxes
The Company and substantially all domestic subsidiaries are members of a group, which files a consolidated Federal income tax return. Federal income taxes or tax benefits are allocated to each company on the basis of its individual taxable income or loss and tax credits included in the return. The Company owns a majority share of The Mosaic Company, a publicly traded fertilizer company, which files separate federal and state income tax returns. Deferred income taxes are recognized for tax consequences of temporary differences by applying enacted statutory tax rates, applicable to future years, to differences between the financial reporting and the tax basis of existing assets and liabilities.
It is generally the policy of the Company to reinvest unremitted earnings of foreign subsidiaries and corporate joint ventures indefinitely, or to remit earnings only when the tax effect is minor. Accordingly, no provision has been made for income taxes that may be payable upon remittance of such earnings. Federal income taxes on any amounts remitted would be partly offset by foreign tax credits.
16. Pension and Postretirement Plans
The Company and its subsidiaries have various pension and postretirement benefit plans covering most of its domestic employees and many of its foreign employees. Pension benefits are based on years of service and compensation. Unrecognized net gains or losses are amortized over the expected remaining service lives of employees. Pensions are funded in compliance with U.S. government regulations or local laws and customs.
17. Share-based Payment Plans
The Company uses the fair value recognition provisions of SFAS 123 and expenses the value of stock options over the service period. In December 2004, The FASB revised SFAS 123. SFAS 123R further defines the concept of fair market value as it relates to share-based payment transactions as compensation expense. The provisions of this statement were effective for the Company in fiscal 2007 and did not have a material effect on the Company’s consolidated financial position or results of operations.
25 Confidential
18. Business Combinations and Goodwill
Business acquisitions are accounted for in accordance with SFAS 141, “Business Combinations,” with the purchase price allocated to the assets and liabilities acquired, including goodwill and other intangibles, based on their estimated fair values at date of acquisition. Under SFAS 142, “Goodwill and Other Intangibles Assets,” goodwill and intangible assets with indefinite lives are not amortized, but are reviewed annually for impairment or upon the occurrence of trigger events. Impairment assessments include comparing the fair value of a reporting unit with its carrying value, including goodwill. The assessments are performed using a variety of methodologies, including cash flow analyses, estimates of sales proceeds and appraisals.
19. Reclassifications
Certain 2006 amounts have been reclassified to conform with the current year presentation.
B. New Accounting Pronouncements
Included below are significant new accounting pronouncements issued effective after the year ended May 31, 2007.
1. Accounting for Uncertainty in Income Taxes
In June 2006, The FASB issued FASB Interpretation 48 (FIN 48), “Accounting for Uncertainty in Income Taxes – an interpretation of SFAS 109.” This interpretation prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. The interpretation also provides guidance on derecognition, classification and other matters. FIN 48 is effective for the Company in fiscal 2008 and is not expected to have a material effect on the Company’s financial position or results of operations.
2. Accounting for Defined Benefit Pension and Other Postretirement Plans
During September 2006, the FASB issued SFAS 158, “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans.” This statement requires an employer to recognize the overfunded or underfunded status of a defined benefit postretirement plan as an asset or liability in its balance sheet and to recognize the changes in the funded status in other comprehensive income in the year in which the changes occur. The statement also requires measurement of the funded status of defined benefit postretirement plans as of the end of the fiscal year instead of a date prior to the end of the fiscal year. Pursuant to SFAS 158, the Company will recognize the funded status of its defined benefit postretirement plans in its consolidated balance sheet as of May 31, 2008, and will adopt the measurement date provisions of SFAS 158 on May 31, 2009. The Company does not expect that adoption of SFAS 158 will have a material effect on consolidated stockholders’ equity.
26 Confidential