-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, CbetD5xKlu8IHuZk2OKkB7xGt0N5vU+a5u2WzZ4k1ghuQSvfYMyiqMcOmxzRZ04E b9LuEGCrhm3K/mcVQKsphQ== 0000897101-97-000960.txt : 19970827 0000897101-97-000960.hdr.sgml : 19970827 ACCESSION NUMBER: 0000897101-97-000960 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 5 CONFORMED PERIOD OF REPORT: 19970531 FILED AS OF DATE: 19970826 SROS: NONE FILER: COMPANY DATA: COMPANY CONFORMED NAME: HARVEST STATES COOPERATIVES CENTRAL INDEX KEY: 0000823277 STANDARD INDUSTRIAL CLASSIFICATION: WHOLESALE-FARM PRODUCT RAW MATERIALS [5150] IRS NUMBER: 410251095 STATE OF INCORPORATION: MN FISCAL YEAR END: 0531 FILING VALUES: FORM TYPE: 10-K SEC ACT: 1934 Act SEC FILE NUMBER: 333-17865 FILM NUMBER: 97669886 BUSINESS ADDRESS: STREET 1: 1667 NORTH SNELLING P O BOX 64594 CITY: ST PAUL STATE: MN ZIP: 55164 BUSINESS PHONE: 6126469433 MAIL ADDRESS: STREET 1: 1667 NORTH SNEFLLING P O BOX 64594 CITY: ST PAUL STATE: MN ZIP: 55164 10-K 1 SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-K --------- [X] Annual report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 for the fiscal year ended May 31, 1997 or [ ] Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 for the transition period from_________ to __________ Commission file number: 333-17865 HARVEST STATES COOPERATIVES (Exact name of registrant as specified in its charter) MINNESOTA 41-0251095 (State or other jurisdiction of (I.R.S. Employer Identification Number) incorporation or organization) P.O. Box 64594 St. Paul, Minnesota 55164 (Address of principal executive office) Registrant's Telephone number, including area code: (612) 646-9433 SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT: NONE SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT: NONE Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YES [X] NO [ ] Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K: Not applicable State the aggregate market value of the voting stock held by non-affiliates of the registrant: The registrant has no voting stock outstanding. Indicate the number of shares outstanding of each of the registrant's classes of common stock, as of the latest practicable date: The registrant has no common stock outstanding. DOCUMENTS INCORPORATED BY REFERENCE No documents are incorporated by reference. INDEX PAGE PART I. NO. --- Item I. Business Grain Merchandising.......................................................... Oilseed Processing and Refining Defined Business Unit........................ Wheat Milling Defined Business Unit.......................................... Farm Marketing and Supply.................................................... Feed......................................................................... Services..................................................................... Membership in the Company and Authorized Capital............................. Item 2. Properties........................................................... Item 3. Legal Proceedings.................................................... Item 4. Submission of Matters to a Vote of Security Holders.................. PART II. Item 5. Market for Registrant's Common Equity and Related Stockholder Matters...................................................................... Item 6. Selected Financial Data Consolidated Company......................................................... Oilseed Processing and Refining Defined Business Unit........................ Wheat Milling Defined Business Unit.......................................... Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operation Consolidated Company......................................................... Oilseed Processing and Refining Defined Business Unit........................ Wheat Milling Defined Business Unit.......................................... Item 8. Financial Statements and Supplementary Data ......................... Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure......................................................... PART III. Item 10 Directors and Executive Officers of the Registrant Board of Directors........................................................... Executive Officers........................................................... Item 11. Executive Compensation.............................................. Item 12. Security Ownership of Certain Beneficial Owners and Management...... Item 13. Certain Relationships and Related Transactions...................... PART IV. Item 14. Exhibits, Financial Statements and Reports on Form 8-K.............. SUPPLEMENTAL INFORMATION..................................................... SIGNATURES................................................................... PART I. ITEM 1. BUSINESS THE COMPANY Harvest States Cooperatives (the "Company") is an agricultural cooperative. Its primary business is merchandising grain, which involves purchase of various grains from its Individual Members, Affiliated Associations and others, sale of the grain to users, exporters and other intermediaries and arranging for the transportation and storage of purchased grain for delivery to buyers. The Company also sells feed and other farm supplies to its Individual Members and others, offers services to its Individual Members and Affiliated Associations, crushes and refines soybeans, through a joint venture participates in the food processing and packaging business and mills wheat. The Company has authorized three classes of membership: Individual Members ("Individual Members"), Affiliated Associations ("Affiliated Associations) and Defined Members ("Defined Members"). Individual Members are producers of agricultural products who have done business with the Company during its last fiscal year and have consented to take patronage into account as contemplated by Section 1388 of the Internal Revenue Code. In the patronage consent filed with the Company, the producer agrees to include both the cash and noncash portion of any patronage refund in taxable income for federal income tax purposes. Affiliated Associations are associations of producers of agricultural products complying with certain federal requirements which have done at least $100,000 of business with the Company during its last fiscal year and have consented to take patronage into account for tax purposes. Defined Members are persons otherwise eligible for membership who hold Equity Participation Units. Individual Members, Defined Members and Affiliated Associations who sell grain to the Company, and Individual Members, Defined Members and Affiliated Associations and consenting patrons who purchase goods and services from the Company are entitled to receive patronage refunds from the Company, which are declared on an annual basis. The Company may also allocate non-member-sourced income to its Members and Non-Member Consenting Patrons in proportion to patronage. The Board of Directors created the Oilseed Processing and Refining Defined Business Unit for the purpose of purchasing soybeans and crude soybean oil and the processing and sale thereof into meal, flour, oil and various byproducts, effective at the close of business on May 31, 1997, to carry on the operations of the Processing and Refining Division. On that date there was allocated to the Oilseed Processing and Refining Defined Business Unit the assets and liabilities, including commitments, contingencies and obligations, appropriately belonging to the Division. In connection with the organization of the Oilseed Processing and Refining Defined Business Unit, the Company has withdrawn an amount sufficient to bring its net worth to $53,390,998, which was its net worth on May 31, 1996. The Board of Directors created the Wheat Milling Defined Business Unit for the purpose of purchasing wheat (including durum) and the processing and sale thereof into flour and various byproducts, effective at the close of business on May 31, 1997, to carry on the operations of the Milling Division. On that date there was allocated to the Wheat Milling Defined Business Unit the assets and liabilities, including commitments, contingencies and obligations, appropriately belonging to the Division. In connection with the organization of the Wheat Milling Defined Business Unit, the Company contributed additional capital so that the construction of the Pocono facility could be financed from equity capital. GRAIN MERCHANDISING Grain and oilseed merchandising involves the sale and distribution of grain and oilseeds from producer to processor, to be processed for human and animal consumption and other uses. These commodities are produced and consumed throughout the world. Increased worldwide demand is generated through population growth and, for certain regions, increased per capita food consumption supported by growing affluence. Demand for these commodities is satisfied by worldwide production, which is in part determined by prevailing prices. A significant portion of high production grains (wheat, corn and soybeans) grown domestically have been exported. United States production competes with production in numerous other countries to supply the worldwide demand for these grains. The ability of producers in particular countries to compete on a worldwide basis may be enhanced by governmental support and protection, though this activity has been declining in recent years. Wheat, corn and soybean exports from the U.S. are projected to increase in the crop year ending May 31, 1998. United States wheat exports are projected to increase from 27.2 million metric tons (MMT) in 1997 to 30 MMT in 1998. The U.S. continues to face competition from Canada, Australia, Argentina and the European Union (EU); however, collectively these countries are projected to reduce their exports from 78.5 MMT in 1997 to 69.8 MMT in 1998 due to production shortfalls. United States corn exports are projected to increase from 45.7 MMT in 1997 to 52.1 MMT in 1998. Argentina, the largest competitor of the U.S., is projected to reduce its exports from 14.7 MMT in 1997 to 13 MMT in 1998. Also, world corn production is expected to be down from 590 MMT in 1997 to 572 MMT in 1998, which should create increased demand for U.S. corn. United States soybean exports are projected to increase from 23.95 MMT in 1997 to 25.72 MMT in 1998. Argentina and Brazil, the major competitors for U.S. exports, are projected to have unchanged exports for 1998 versus 1997. The U.S. gain in exports is projected to come from demand from China. The Company expects that its export business will increase consistent with the increase in U.S. exports. Historical information and projections for the 1997 and 1998 crop years are from information published by the United States Department of Agriculture. Imports of grains into the U.S. consist mainly of wheat, oats and barley. The amounts imported have not had a material effect on grain merchandising. In the United States, grain merchandising involves the purchase of grain, sale for export or further domestic use and storage and transportation to export facilities or to users. Grain merchandising may be adversely affected by supply and demand relationships, both domestic and international. Supply is affected by weather conditions, disease, insect damage, acreage planted, government regulation and policies and commodity price levels. The business is also affected by transportation conditions, including rail, vessel, barge and truck. Demand may be affected by foreign governments and their programs, relationships of foreign countries with the United States, the affluence of foreign countries, acts of war, currency exchange fluctuations and substitution of commodities. Demand may also be affected by changes in eating habits, by population growth and increased or decreased per capita consumption of some products. Recent Developments. High grain and oilseed prices in the years ended May 31, 1996 and 1997 promoted increased production and resulted in larger inventories held by producers at May 31, 1997. Prices for most grains and oilseeds are at or near three year lows due to the increased supplies. The following table shows the cash prices per bushel for the major grains on June 1, 1996 and May 31, 1997: June 1, May 31, Grain 1996 1997 ----- ------- ------------ Wheats $6.49 $3.91 Corn 4.69 2.51 Soybeans 7.51 6.98 Because the profitability of the Company is primarily determined by margins, changes in grain prices do not directly impact the Company's income. However, grain prices may be reflective of the demand for grain (particularly grain to be exported) and therefore give an indication of the grain volume the Company may handle within a crop year. The Freedom to Farm Act of 1996, enacted in April 1996, has had a profound effect on the production patterns within the United States. The flexibility of the program allows producers to grow crops which provide the highest financial return. For example, this year the U.S. producer reacted to short supplies and high prices of soybeans in the year ended May 31, 1997 with a tremendous increase in acreage for the year ended May 31, 1998. U.S. export subsidies, principally the Export Enhancement Program, continue to decline in importance and overall use. The Company's operations depend more on the volume of grain handled than the price of grain. In addition, the price of grain should have little effect on either the Wheat Milling or Oilseed Processing and Refining Defined Business Units, which are more dependent on manufacturing margins. Introduction The Company buys grain through its Grain Marketing Division from Affiliated Associations (typically a cooperative organization of local producers), directly from Individual Members (to a limited extent) and from third parties (such as grain dealers, non-Member producers, marketing associations or marketing pools, elevators and other grain merchandising companies) and through its Agri-Service Centers, which are country elevators owned by the Company, directly from Individual Members. Grain purchased by Agri-Service Centers is usually sold to the Grain Marketing Division for resale. A small portion of grain is handled on a consignment basis. Grain is sold by the Company for future delivery at a specified location. Grain sold by a producer is typically trucked to a local elevator for sale. From local elevators, grain may be transported in a variety of ways to the purchaser. The Company arranges transportation to delivery locations using truck, rail and barge transportation. Grain intended for export may be shipped by rail to an export terminal or to a barge loading facility to be shipped by barge to an export terminal, where it is loaded on an ocean-going vessel. Grain intended for domestic use may be shipped by truck or rail to various locations throughout the United States. Because of its facilities, the Company has significant capacity to sell grain for export. Purchases. The number of bushels of grain purchased from Individual Members and Affiliated Associations, the total grain purchased and the percentage relationship for each of the years ended May 31 are set forth below: Years Ended May 31, ------------------- 1997 1996 1995 ---- ---- ---- Member purchases 757,704,610 959,166,596 720,024,458 Total purchases 1,280,557,384 1,692,438,700 1,148,952,019 Percentage 59.2% 56.7% 62.7% Substantially all of the grain purchased by the Company is grown in the Midwest, Great Plains and Pacific Northwest. The Company also purchases grain grown in other parts of the United States and other countries. Grains Handled. The primary grains merchandised by the Company are corn, wheat and soybeans. The Company also merchandises barley, milo, sunflowers and oats as well as smaller quantities of canola, flax, rye, millet and others. The number of bushels of grain purchased by the Company for the periods indicated is set forth below: Years Ended May 31, ------------------- 1997 1996 1995 ------------- ------------- ------------- Wheat ...... 478,978,426 505,606,729 457,684,648 Corn ....... 425,851,278 777,631,466 342,832,256 Soybeans ... 219,686,914 234,930,247 172,025,373 Barley ..... 61,839,145 75,225,773 93,699,078 Milo ....... 51,722,961 48,199,610 36,663,822 Sunflowers . 14,603,180 25,952,855 28,929,026 Oats ....... 22,487,231 20,008,442 13,423,696 All other .. 5,388,249 4,883,578 3,694,120 ------------- ------------- ------------- 1,280,557,384 1,692,438,700 1,148,952,019 ============= ============= ============= Sales of grain by the Company for each of the years ended May 31 are set forth below: 1997 1996 1995 -------------- -------------- -------------- Wheat ... $2,490,328,502 $2,631,202,689 $1,890,923,540 Corn .... 1,558,440,294 2,518,939,007 954,570,208 Soybeans 1,421,789,252 1,431,485,630 880,627,929 All other 565,944,576 545,596,081 465,543,859 -------------- -------------- -------------- TOTAL ... $6,036,502,624 $7,127,223,407 $4,191,665,536 ============== ============== ============== Recent Developments. United States grain exports declined in the year ended May 31, 1997 to a three year low for wheat, soybeans and corn (96.9 million metric tons). In the year ended May 31, 1998, exports are projected to rebound to 107.7 million metric tons for the same three commodity groups. The U.S. will produce a large portion of the exportable supplies in the world as the major export competitors are experiencing production shortfalls. As a result, the Company expects that its own export handle of these commodities will increase with a potential increase in overall volume handled of 5 to 10% in the year ending May 31, 1998. Historical information and projections for the 1997 and 1998 crop years are from information published by the United States Department of Agriculture. Merchandising The Company buys and sells grain through offices of its Grain Marketing Division located in Portland, Oregon, Great Falls, Montana, Lincoln, Nebraska, Kansas City, Kansas, St. Paul, Minnesota, Winona, Minnesota, Davenport, Iowa, and at its Agri-Service Centers. Grain purchased through Agri-Service Centers is purchased on a cash and futures basis. Grain purchased through the Grain Marketing Division is usually purchased for future delivery. Grain is sold for future delivery at a specified location, with the Company usually responsible for arranging necessary transportation to that location. Purchasers include millers, malters, exporters and foreign buyers as well as the soybean, wheat and feed operations of the Company. The Company is not dependent on any one customer. The Company has supply relationships calling for delivery of grain at prevailing market prices. Grain users store varying amounts of grain for their own use. The Company's ability to arrange transportation is a significant part of the service it offers to its customers. The Company's loading capabilities onto unit trains, ocean going vessels and barges is a component of the selling price of grain handled by the Company. Rail transportation is through independent railroads, although approximately 30% of rail movement for Grain Merchandising for the year ended May 31, 1997, was carried out through leased railcars (either directly or by use of pools in which such leased railcars participate). Vessel and truck transportation is carried out exclusively by third parties. Barge transportation is carried out by third parties, but the Company is a party to long-term affreightment agreements for approximately 20% of current needs. Virtually all grain sold domestically is sold by employees while approximately half of grain exported is sold by brokers or agents and the balance by employees. The Company has a small ownership position in Intrade, a company which owns part of a Germany-based marketing organization involved in trading grain and feedstuffs in Germany and international markets. The Company also has relationships with agents, brokers and marketing companies in other countries to assist it in export sales. Competition The Company competes for both the purchase and sale of grain. Competition is intense and margins are low. Some of the Company's competitors are integrated food producers, which may also be customers. Many competitors have substantially greater financial resources than the Company. In the purchase of grain from producers, location of a delivery facility is a prime consideration but producers are willing to truck grain for sale over increasingly longer distances. Grain prices are affected by reported trading prices on national markets, shipping costs and storage capabilities. Price is affected by the capabilities of the facility. For example, if it is cheaper to deliver to a customer by unit train than by truck, a facility with unit train capability provides a price advantage. The Company believes that its relationship with Individual Members serviced by local Agri-Service Centers and with Affiliated Associations gives it a broad origination capability. The Company competes in the sale of grain based on price and its ability to provide quantity and quality of grains required and its ability to deliver. Location of facilities is a major factor in ability to compete. Major grain merchandising companies in addition to the Company include Archer-Daniels-Midland, Cargill, Continental, ConAgra, Bunge and Louis Dreyfus, each of which handles grain volumes of more than one billion bushels annually. The Company estimates it would be among the smaller merchandisers among these seven. The Company also competes with numerous other grain merchandisers with annual volumes of less than one billion bushels. Since the Company's facilities are located primarily in the Midwest, Great Plains and Pacific Northwest, with a terminal in the Gulf, the Company primarily competes with the companies whose facilities are in these areas. The Company's export facilities in three major areas allow it to ship to anyplace in the world. Grain Handling and Transportation The Company owns export terminals, river terminals and other elevators involved in the handling of grain. All such facilities can receive inbound truck and rail. Export facilities on river systems can receive grain by barge. In addition, the Company owns 154 Agri-Service Centers, which are country elevators which receive grain from producers. The Company operates river terminals at Kansas City, Missouri (two), St. Paul, Savage and Winona, Minnesota, and Davenport, Iowa (two), which are used to load grain onto barges for shipment to both domestic and export customers via the Mississippi River system, on trucks for domestic markets and on rail for both domestic and export markets. The Company owns and operates a terminal at Kennewick, Washington, on the Columbia River. The Company has interests in three river terminals located on the Snake River: Lewis and Clark Terminal Association's facility located at Lewiston, Idaho, Central Ferry Terminal Association's facility located at Central Ferry, Washington and Co-Grain Elevator Company's facilities located at Upper Monumental and Burbank, Washington. Much of the grain from these terminals is loaded onto barges for shipment to Pacific Northwest export terminals. The Company's export terminal at Superior, Wisconsin, provides access to the Great Lakes and St. Lawrence Seaway, and the Company's export terminal at Myrtle Grove, Louisiana, serves the Gulf market. An export terminal at Kalama, Washington, leased by the Company, and an export terminal at Vancouver, Washington, owned by a joint venture partner, serve the Pacific market. A partnership between the Company and Continental Grain Company operates an export terminal at Tacoma, Washington, for feed grain and oilseed shipments to Pacific Rim customers. A facility in Spokane, Washington is used for storage and transloading. An elevator in Petersburg, North Dakota, is used to standardize barley for a particular customer. The Division leases a fleet of covered hopper cars and enters into various contracts for covered grain barges. In addition, at various times the Company may charter vessels. Price Risk and Hedging Upon purchase, the Company has risks of carrying grain, including price changes and performance risks (including delivery, quality, quantity and shipment period), depending upon the type of purchase contract entered into. These contracts include flat price, basis fixed, delayed price, deferred payment, hedge to arrive and futures fixed. The Company is exposed to risk of loss in the market value of positions held, consisting of grain inventory and purchase contracts at a fixed or partially fixed price, in the event market prices decrease. The Company is also exposed to risk of loss on its fixed price or partially fixed price sales contracts in the event market prices increase. To reduce the price change risks associated with holding fixed price positions, the Company generally takes opposite and offsetting positions by entering into grain commodity futures contracts (either a straight futures contract or an options futures contract) on regulated commodity futures exchanges. Most of the grain volume handled by the Company can be hedged. Some grains cannot be hedged because there are no futures for certain commodities. For those commodities, risk is managed through the use of forward sales and different pricing arrangements and to some extent cross-commodity futures hedging. While hedging activities reduce the risk of loss from changing market values of grain, such activities also limit the gain potential which otherwise could result from changes in market prices of grain. The Company's policy is to generally maintain hedged positions in grain which is hedgeable, but the Company can be long or short at any time. The Grain Marketing Division's profitability is primarily derived from margins on grain merchandised and revenues generated from other merchandising activities with its customers, not from hedging transactions. Hedging arrangements do not protect against nonperformance of a contract. When a futures contract is entered into, an initial margin deposit must be sent to the applicable exchange. The amount of the deposit is set by the exchange and varies by commodity. If the market price of a short futures contract increases, then an additional margin deposit (maintenance margin) would be required. Similarly, if the price of a long futures contract decreases, a maintenance margin deposit would be required to be sent to the applicable exchange. Subsequent price changes could require additional maintenance margins or could result in the return of maintenance margins. At any one time the Grain Marketing Division's inventory and purchase contracts for delivery to the Company may be substantial. The Grain Marketing Group has a risk management policy and procedures that include net position limits. It is defined by commodity and includes both trader and management limits. This policy and computerized procedure triggers a review by management of the Grain Marketing Division when any trader is outside of position limits and also triggers review by management of the Company if the Grain Marketing Division is outside of its position limits. The position limits are reviewed at least annually with management of the Company. The Company monitors current market conditions and may expand or reduce the purchasing program in response to changes in those conditions. In addition, certain purchase and sale contracts are subject to credit approvals and appropriate terms and conditions. Seasonality Harvest for most crops occurs in the summer and fall, and the Company purchases more grain during that period. Because of the Company's geographic location and the fact that it is further from its export facilities, grain tends to be sold later than in other parts of the country. Because many producers have significant on-farm storage capacity and because of the Company's own storage capacity, grain is bought and moved throughout the year. Working Capital Due to the amount of grain purchased and held in inventory, the Company has significant working capital needs at various times of the year. The amount of borrowings for this purpose and the interest rate charged on such borrowings directly affect the profitability of the grain merchandising operations. Employees As of May 31, 1997, the Grain Marketing Division had 458 employees, of which 81 were traders, 243 production staff, 14 management and 120 support staff. See "Farm Marketing and Supply" with respect to employment by Agri-Service Centers. Of these employees, 149 at five locations are subject to collective bargaining agreements expiring at various times through 1999. OILSEED PROCESSING AND REFINING DEFINED BUSINESS UNIT The soybean crushing industry converts soybeans into meal used for feeding animals, soy flour used for specialty food and other purposes and crude soybean oil. The soybean refining industry refines the crude oil for use in processed foods, such as margarine, salad dressings and baked goods, and to a more limited extent industrial uses. Soybean production is concentrated in the central United States, Brazil, China and Argentina. Crushing plants are generally located in proximity to sources of soybeans and usage of meal often arises in proximity to crushing plants. Refineries are generally located next to the crushing plants. Oil is shipped throughout the United States and for export. Per capita domestic consumption of soybean oil has declined slightly in recent years. Exports of soybean oil are variable but generally a minor portion of total production. In recent years, exports have varied widely, which dramatically influenced margins in both crushing and refining. Usage of meal is dependent on the amount of livestock being raised, which has increased in recent years. While per capita domestic consumption of meat has been stable in recent years, demand for meal has increased due to an increase in the domestic consumption of pork and poultry and an increase in meat exports. Soybean meal provides a ready source of protein with a 44% or higher protein content, compared to corn at 9%, wheat at 9.5% and barley at 11.5% Major competitors in the industry include the Company, Archer-Daniels-Midland (ADM), Cargill, Ag Processing, Inc. ("AGP"), Central Soya and Bunge. Competition is driven by price, transportation costs, service and product quality. The industry is highly competitive. These and other competitors are adding new plants and expanding capacity of existing plants. Unless exports increase or existing refineries are closed, this extra capacity is likely to put additional pressure on prices and erode margins. Several competitors operate over various market segments and may be suppliers to or customers of other competitors. Historically, in the Company's trade area there has been an adequate supply of soybeans, even in years when there has been a substantial amount of soybeans exported. While the price of soybeans has fluctuated substantially, the prices of meal and oil have followed, so that margins have been maintained. The amount of soybeans held in inventory domestically at the end of the 1997 crop year (at August 31, 1997) is the lowest in 20 years. At its integrated crushing and refining facility in Mankato, Minnesota, the Oilseed Processing and Refining Defined Business Unit processes soybeans into soybean meal, soyflour and crude soybean oil. The crude soybean oil, with additional purchased crude oil, is refined. Equity Participation Units At May 31, 1997, Equity Participation Units in the Oilseed Processing and Refining Defined Business Unit represented the right to deliver 1,074,000 bushels of soybeans, approximately 3% of the processing capacity of the Defined Business Unit. Price Risk and Hedging To reduce the price change risks associated with holding fixed price commodity positions, the Company generally takes opposite and offsetting positions by entering into commodity futures contracts (either a straight futures contract or an options futures contract) on regulated commodity futures exchanges. While hedging activities reduce the risk of loss from changing market values of oilseeds, such activities also limit the gain potential which otherwise could result from changes in market prices of oilseeds. The Company's policy is to generally maintain hedged positions, but the Company can be long or short at any time. The Defined Business Unit's profitability is primarily derived from margins on oilseeds processed, not from hedging transactions. Management does not anticipate that its hedging activity will have a significant impact on future operating results or liquidity. Hedging arrangements do not protect against nonperformance of a contract. At any one time the Defined Business Unit's inventory and purchase contracts for delivery to the Defined Business Unit may be substantial. The Defined Business Unit has a risk management policy and procedures that includes net position limits. It is defined by commodity and includes both trader and management limits. This policy and computerized procedure triggers a review by management of the Defined Business Unit when any trader is outside of position limits and also triggers review by management of the Company if the Defined Business Unit is outside of its position limits. The position limits are reviewed at least annually with management of the Company. The Defined Business Unit monitors current market conditions and may expand or reduce the purchasing program in response to changes in those conditions. In addition, certain purchase and sale contracts are subject to credit approvals and appropriate terms and conditions. Supply The Oilseed Processing and Refining Defined Business Unit purchases virtually all of the soybeans processed by it from Members. The balance is purchased in the commercial marketplace. Because the Oilseed Processing and Refining Defined Business Unit has not had long-term contracts with customers, it does not obligate itself to purchase soybeans based on orders received from customers but instead on its contemplation of future production. The Oilseed Processing and Refining Defined Business Unit does not hold significant inventories of raw beans; capacity for raw bean storage is approximately three to four weeks of production. At any one time, inventories of beans and contracts for future delivery represent two to ten weeks of requirements. Inventories of raw beans and contracted purchases for future delivery are substantially hedged. The Oilseed Processing and Refining Defined Business Unit also purchases crude soybean oil for processing at its refinery. Approximately 40% of the crude oil refined is produced by the Oilseed Processing and Refining Defined Business Unit, and the balance is purchased. Major suppliers have been AGP and ADM. Because ADM is opening a refinery late in 1997 in Minnesota, it will no longer be a major supplier of crude oil. However, there are several producers of crude oil, and the Company believes it will be able to replace this supply source. The refining facility has storage capacity for approximately 10 days' supply of crude oil, so it depends on a steady supply of crude oil to supplement its own output of crude oil to maintain constant production. It typically commits for several months' supply, to be priced prior to delivery. As with other agricultural commodities, the availability and price of soybeans fluctuate with forces of supply and demand. The Oilseed Processing and Refining Defined Business Unit has never experienced a supply shortage of soybeans. Customers Refined Oils. The Oilseed Processing and Refining Defined Business Unit sells refined oil throughout most of the United States although it concentrates on customers located in Minnesota, Wisconsin, North Dakota, South Dakota, northern Iowa and northern Illinois, which can be reached by truck rather than rail and are therefore slightly more profitable. Customers in these states accounted for more than 50% of refined oil sales in the year ended May 31, 1997. The Company estimates that of oil sold, 25% is used for margarine, 15 to 20% for salad dressing and smaller percentages for snack foods, baked goods, imitation cheese goods, processed potato goods and others. Approximately 5% of oil sales are for industrial use. During the year ended May 31, 1997, the Oilseed Processing and Refining Defined Business Unit had over 100 customers, the largest of which was Ventura Foods and its predecessor operations described in the next paragraph. One other customer was responsible for over 10% of refined oil sales by the Defined Business Unit. Sales of refined oil are made by Defined Business Unit employees and to a lesser extent by brokers. The Company has a long-term supply agreement with Ventura Foods, LLC. which commenced January 1, 1997 and will continue for 15 years or longer if the Company continues to hold at least a 25.5% interest in Ventura Foods. The Company has agreed to supply and Ventura has agreed to purchase a minimum quantity of soybean salad oil, hydrogenated soybean oil and other edible oils which the Company may refine during the term of the agreement. The Company has agreed to sell to Ventura Foods, and Ventura Foods has agreed to purchase from the Company, during each calendar year at least 430,000,000 pounds of products or 50% of its requirements if greater, but not more than 100% of its requirements. The price for the products sold to Ventura Foods is a formula adjusted annually to be competitive with alternative sources. Soybean Meal. Soybean meal sold by the Oilseed Processing and Refining Defined Business Unit is used for feeding livestock. During the year ended May 31, 1997, the Defined Business Unit sold meal to over 500 customers, primarily feed lots and feed mills. During the year ended May 31, 1997, ten customers accounted for approximately 55% of meal sold, and two customers, which would be difficult to replace, accounted for approximately 34% of meal sold. For the year ended May 31, 1997, 55% of meal was sold in Minnesota, 25% in Wisconsin, 13% in Canada and the balance in Iowa, North Dakota, South Dakota and Montana. These sales could be adversely affected by a decline in the livestock or turkey industries in these areas. Substantially all meal sales are made directly by employees of the Defined Business Unit. Soyflour. Soyflour is used in the baking industry, as milk replacers in animal feed and in industrial applications. Sales of soyflour have not been significant relative to sales of meal. Dependence on Customers. Other than Ventura Foods, only one additional customer accounted for more than 10% of the Oilseed Processing and Refining Defined Business Unit's sales in the year ended May 31, 1997. Competition The Company believes that the Oilseed Processing and Refining Defined Business Unit has 6 to 8% of the refined soybean oil market and less than 3% of the soybean crushing capacity. Processing Soybeans arriving by truck or rail are sampled, weighed, dumped and unloaded into bean storage. When brought out of storage, beans are cleaned, dehulled, cracked and conditioned and are compressed into flakes. Oil is removed from the flakes through a solvent process. Flakes are then further processed into soyflour or soymeal. Soymeal can be made into animal feed at various protein levels. Crude oil is filtered to remove remaining meal particles and centrifuged to separate out trace constituents. The oil can be sold as an industrial product used in plastics, inks and paints. Further processing prepares the oil for food use, by bleaching with a special clay to remove trace metals, chlorophyll and other impurities to make salad oil. By adding hydrogen under pressure to bleached oil, the Company makes partially hydrogenated soybean oil which may be used in products such as shortenings or margarines. To remove unwanted odors, flavors and mild color constituents, bleached or hydrogenated oil is heated under vacuum. The result is a product that is flavorless, odorless, tasteless and virtually clear. While the Oilseed Processing and Refining Defined Business Unit runs at between 80 to 100% of capacity throughout the year, volume is typically higher at harvest time since soybean supplies are more abundant in the fall. Producer and cooperative elevator storage capabilities allow suppliers to sell for delivery throughout the year. Facilities The Oilseed Processing and Refining Defined Business Unit has one facility located in Mankato, Minnesota, comprised of a crushing plant, a refinery, a soyflour plant and self contained utilities. A quality control lab with technically sophisticated equipment assures high quality standards. The Defined Business Unit expects to expend approximately $14 to $24 million over the two years ending May 31, 1999, to expand the capacity of its crushing plant, to increase processing efficiency and to meet environmental requirements. The Company expects that such construction will be financed from long-term borrowings. Employees The Oilseed Processing and Refining Defined Business Unit currently employs 202 employees, 34 in the office in administration, sales and support service and 168 in the plant. Certain production workers are subject to collective bargaining agreements with the American Federation of Grain Millers (131 employees) expiring in 1998 and the Pipefitters' Union (2 employees) expiring in 1997. Ventura Foods On August 30, 1996, the Company and Wilsey Foods, Inc. combined the assets and certain liabilities of the Company's Holsum Foods Consumer Products Packaging Division with the assets and liabilities of Wilsey Foods, Inc. as Ventura Foods, LLC ("Ventura Foods"). A joint venture owned by Wilsey Foods, Inc. and the Company which operated a manufacturing facility in Chambersburg, Pennsylvania, was merged into Ventura Foods. The Company owns 40% and Wilsey Foods owns 60% of the equity and rights to distribution of profits of Ventura Foods. The Company's total net investment in Ventura Foods was $38,491,000 as of August 30, 1996. Sales by the Oilseed Processing and Refining Defined Business Unit to Ventura Foods and its predecessors in interest are shown below: Oilseed Processing and Refining Defined Business Unit's Sales to Holsum, Wilsey & Ventura Years Ended May 31, ------------------- 1997 1996 1995 ------------ ------------ ----------- Sales ($) $110,679,000 $124,299,000 $79,133,000 Percentage of total refinery sales ........... 45% 45% 30% Ventura Foods is in the business of manufacturing and/or packaging and selling food products, including salad dressings, mayonnaise, margarine, salad oils, jams, jellies, olives, syrups, soup bases and sauces. Its customers are national. Ventura Foods is governed by a committee, and each of the Company and Wilsey Foods appoints half the committee members. Neither the Company nor Wilsey Foods may transfer any part of its interest in Ventura Foods until September 1, 1999. Thereafter a transferring party must retain at least a 25.5% interest in Ventura Foods. Ventura Foods will be dissolved if it has cumulative losses in excess of $25 million or is unable to discharge its liabilities as they become due. WHEAT MILLING DEFINED BUSINESS UNIT The Company's Wheat Milling Defined Business Unit mills durum wheat into flour and semolina and, to a lesser extent, mills spring and winter (hard) wheats into bread flour. The Wheat Milling Defined Business Unit is the largest miller of durum wheat in the United States. The Wheat Milling Defined Business Unit had historically concentrated on durum wheat milling at its Rush City and Huron facilities. With the opening of its Kenosha mill in late 1995, which can produce durum and bakery flours, and its Houston facility, which began limited production in June 1997 and produces bakery flour, the Defined Business Unit has broadened its markets and significantly increased its capacity. Semolina and Durum Flour. Durum wheat millers process durum wheat into semolina and durum flours. Semolina and high grade durum flours are the chief ingredient in pasta; low grade durum flour is used for pet food. Durum is grown in arid regions of the United States, such as North Dakota and certain areas of the Southwest, as well as in other countries. Most of the quality durum is grown in the Midwest, particularly North Dakota. Durum milling plants are generally located in proximity to customers; wheat is shipped to the mill for milling. Sale of semolina and durum flour is entirely dependent on pasta production. Per capita consumption of pasta has continued to increase in recent years, and the number of consumers continues to grow with population growth. Pasta in its many forms is sold at retail, for restaurants and institutional use and for use in other processed food products. Imported pasta accounted for approximately 12% of the domestic market in the year ended May 31, 1997. The International Trade Commission in July 1996 determined that certain Italian and Turkish companies benefited unfairly from subsidies and had sold product in the United States at less than fair value and imposed countervailing and anti-dumping duties. Despite the imposition of duties, imports have slightly increased. Major competitors in the industry include the Company, Italgrani and Miller Milling. Competition is driven by price, service and product quality. Some competitors have developed long-term relationships with customers by locating plants adjacent to pasta manufacturing plants. Bakery Flour. Bakery flour milled from spring and hard winter wheat is used in breads, cookies, pizza crusts, tortillas and other products. The baking industry is highly fragmented, with the largest participant being no more than four percent of the market. Demand for bakery flour has been stable, as total production and per capita consumption increased in the year ended May 31, 1997. New dietary guidelines established by the United States Department of Agriculture emphasize cereal grains in the food pyramid. The Company believes that demand for bakery flour will increase based on population growth. Imports and exports of bakery flour do not significantly affect the domestic business. Equity Participation Units At May 31, 1997, Equity Participation Units in the Wheat Milling Defined Business Unit represented the right to deliver 4,787,000 bushels of wheat, approximately 11% of the processing capacity of the Defined Business Unit before the construction of the Pocono mill. Price Risk and Hedging To reduce the price change risks associated with holding fixed price commodity positions, the Company generally takes opposite and offsetting positions by entering into commodity futures contracts (either a straight futures contract or an options futures contract) on regulated commodity futures exchanges. Most of the grain volume handled by the Company can be hedged. Some grains, such as durum, cannot be hedged because there are no futures for certain commodities. For those commodities, risk is managed through the use of forward sales and different pricing arrangements and to some extent cross-commodity futures hedging. While hedging activities reduce the risk of loss from changing market values of grain, such activities also limit the gain potential which otherwise could result from changes in market prices of grain. The Defined Business Unit's policy is to generally maintain hedged positions in grain which is hedgeable, but the Company can be long or short at any time. The Defined Business Unit's profitability is primarily derived from margins on grain processed, not from hedging transactions. Management does not anticipate that its hedging activity will have a significant impact on future operating results or liquidity. Hedging arrangements do not protect against nonperformance of a contract. At any one time the Defined Business Unit's inventory and purchase contracts for delivery to the Defined Business Unit may be substantial. The Defined Business Unit has a risk management policy and procedures that includes net position limits. It is defined by commodity and includes both trader and management limits. This policy and computerized procedure triggers a review by management of the Defined Business Unit when any trader is outside of position limits and also triggers review by management of the Company if the Defined Business Unit is outside of its position limits. The position limits are reviewed at least annually with management of the Company. The Defined Business Unit monitors current market conditions and may expand or reduce the purchasing program in response to changes in those conditions. In addition, certain purchase and sale contracts are subject to credit approvals and appropriate terms and conditions. Supply Most of the durum, spring and winter wheats processed by the Wheat Milling Defined Business Unit is purchased from Members. Some grain is purchased from Canada and a small percentage is purchased from the Southwest. Semolina and durum flour sales are hedged to a significant extent by buying durum at the time of pricing the semolina or flour. To minimize the price volatility for winter and spring wheats, the Wheat Milling Defined Business Unit usually hedges by purchasing wheat futures at the time of pricing the flour. There is no futures market for durum, and except for limited cross hedging using other commodities, the Wheat Milling Defined Business Unit does not hedge durum. The availability, price and quality of durum and spring and winter wheat affect the operations and profitability of the Wheat Milling Defined Business Unit. The Wheat Milling Defined Business Unit has never experienced a supply shortage of durum, but shortages have affected prices. Customers Semolina & Durum Flour. The Wheat Milling Defined Business Unit sells semolina and durum flour to eight major customers and approximately 50 smaller customers, which are large and mid-size pasta manufacturers in the United States. In the year ended May 31, 1997, over 34% of the Wheat Milling Defined Business Unit's total production was sold to its two largest customers, Borden (23% of sales) and Hershey (11% of sales), which are estimated by the Company to represent a majority of the country's pasta production. The Wheat Milling Defined Business Unit would be adversely affected by the loss of either of these customers or a decline in the market share of either customer. See "Management's Discussion and Analysis of Financial Condition and Results of Operation -- Wheat Milling Defined Business Unit" with respect to plant closures by Borden. The Wheat Milling Defined Business Unit would be adversely affected by a decline in pasta production in the United States. Most of the Wheat Milling Defined Business Unit's products are marketed by employees of the Defined Business Unit. The Wheat Milling Defined Business Unit uses outside agents and distributors for the balance of its production. Bread Flour. The baking industry is composed of many companies. No one customer buys more than 16% of the Wheat Milling Defined Business Unit's bread flour production. The Company believes because of the large number of potential customers and the fact that the Wheat Milling Defined Business Unit is not dependent on any customer, it would not have substantial difficulty in replacing an existing customer. The Wheat Milling Defined Business Unit's first hard wheat milling unit (Kenosha) began production in late 1995. In October 1996, the Wheat Milling Defined Business Unit expanded hard wheat capacity with the addition of a swing mill at Kenosha capable of milling either durum or hard wheat flour. A plant in Houston, which began limited production in June 1997, added additional hard wheat capacity. The Company believes that there is a substantial customer base available in the Houston area, as well as export markets. The mill serves a sizeable population base and there are no other milling facilities within the area. Competition Durum Milling. The Wheat Milling Defined Business Unit's largest competitors in durum milling are Italgrani and Miller Milling Company. Dakota Growers has expanded its Carrington, North Dakota, milling facility and its pasta production capacity. Philadelphia Macaroni is building a semolina mill in Minot, North Dakota. "Milling and Baking News" reported that General Mills is expanding its mill in Great Falls, Montana. The Company has heard that Italgrani is converting its durum milling capacity in Ayers, Massachusetts, to hard wheat milling. Bread Flour. Competitors include ConAgra, ADM, Cargill, Bay State Milling, Cereal Foods and General Mills. All of these competitors have multiple milling facilities with larger bakery flour production capacity than the Wheat Milling Defined Business Unit. Capacity for hard wheat milling has been expanding faster than consumption. This additional capacity may put pressure on margins. Processing The Defined Business Unit mills wheat into flour using standard industry processes. More recently manufactured equipment has reduced the labor component of wheat milling. The Company believes that its facilities are, on average, newer than its competitors. Operations are somewhat seasonal in anticipation of reduced demand for pasta in summer months. Facilities The Wheat Milling Defined Business Unit has four milling facilities in operation, including Houston which began limited production in June 1997. Each facility includes a milling plant as well as an elevator to store grain. Information on the four mills, plus the planned Pocono mill described below, is set forth below: Location Grain Milled Capacity -------- ------------ -------- Rush City, MN Primarily durum 10,000 cwts/day Huron, OH Primarily durum 14,500 cwts/day Kenosha, WI Durum 11,000 cwts/day Spring and winter wheat 10,000 cwts/day Houston, TX Spring and winter wheat 13,000 cwts/day Pocono, PA Durum 4,000 cwts/day Spring and winter wheat 14,000 cwts/day --------------- Total 76,500 cwts/day =============== The Rush City and Kenosha facilities are owned entirely by the Company. At Houston, the milling plant is constructed on property leased from the Port of Houston on a long-term basis and the elevator is owned by the Port of Houston, but is subject to a put through agreement with the Company. The Huron facility is leased on a long-term basis, but the equipment is owned. Because transportation costs for durum, spring and winter wheats are cheaper than for the milled products, it is a strategic advantage for a mill to be located close to a large customer base rather than close to the producer. Each of the Huron, Kenosha and Houston mills are in proximity to a large customer base. Approximately 85% of the Wheat Milling Defined Business Unit's current milling capacity uses equipment that is less than 10 years old. This newer equipment generates cost advantages in labor, energy, improved yields and better and more consistent products. In the last few years, some competitors have closed less efficient mills in less strategic locations. The Wheat Milling Defined Business Unit will begin constructing semolina and flour and bread flour mills in Pocono, Pennsylvania in the Fall of 1997. The Harvest States Board of Directors has increased the authorized expenditures from $38,800,000 to $41,350,000 for the construction of this mill. Of this amount, $30,000,000 is projected to be expended in fiscal year 1998. For the year ended May 31, 1997 the Wheat Milling Defined Business Unit facilities ran at 97% of capacity based upon a year of 307 operating days being 100%. Employees As of May 31, 1997 the Wheat Milling Defined Business Unit employed the following full time equivalents: production (104), plant management (22) and headquarters (21). Of these, 31 production workers at the Rush City Mill are subject to a collective bargaining agreement with the American Federation of Grain Millers expiring in 1998. FARM MARKETING AND SUPPLY The Farm Marketing and Supply Division owns and operates Agri-Service Centers at 154 locations in Minnesota, North Dakota, South Dakota, Montana, Idaho and Washington. Agri-Service Centers sell farm supplies, including fertilizer, feed, seed and crop protection products, and other related services and have grain elevator operations that buy grain. Some Centers have only grain operations or grain and feed operations, while some have only supply operations. Locations are grouped together into 74 units for operational purposes. A small number of Centers are grouped into seven regionalizations, which have their own producer board and participate in separate patronage pools. Agri-Service Centers purchase grain from member and non-member producers and others, such as other elevators and grain dealers. Of these facilities, 55 have the capability of loading unit trains, while other facilities can load only single cars or are truck stations. Most of the grain purchased is sold through the Company's Grain Marketing Division, with the balance going to local feed and grain processors. The supplies and services offered vary from location to location. Agronomy supplies and services are sold at approximately 70 locations to member and non-member producers. Feed is sold at approximately 75 locations. Agronomy and feed sales are considered distinct operations involving different expertise and sales forces. Most feed sold is purchased from the Feed Division. Fertilizer is obtained from co-op sources and other suppliers. Crop protection products are bought through co-op programs and directly from industry sources. Other goods are obtained through commercial channels. The Company has increased the number of Agri-Service Centers in recent years. The number of centers, operating units, bushels of grain sold and sales at centers for the years ended May 31 are shown below:
1997 1996 1995 1994 1993 -------------- -------------- -------------- -------------- -------------- No. of centers.. 154 144 121 115 105 No. of op. units 74 47 43 43 42
Grain sales (bu) 199,922,000 214,085,000 159,891,000 141,238,000 175,492,000 Sales .......... $1,136,700,000 $1,126,600,000 $ 679,200,000 $ 613,151,000 $ 651,697,000
Competitors for the purchase of grain include other elevators and large grain marketing companies. Competitors for the sale of agronomy supplies and feed include a variety of cooperative and privately owned facilities. The Company competes on the basis of service and patronage. The Division is exploring and pursuing the expansion of track at a number of locations to accommodate 108-car loading due to recent rate changes by the railroads which provide a rate advantage for 108-car trains over 54-car trains. On May 31, 1997, the Division had 764 full time employees and 338 temporary employees. Fin-Ag, Inc. Fin-Ag, Inc. is a wholly owned subsidiary of the Company located in Sioux Falls, South Dakota. It provides seasonal cattle feeding and swine financing loans, facility financing loans and crop production loans for producers. It also provides consulting services to member cooperatives. Its competitors are other financial institutions. Most whole loans are sold to the St. Paul Bank for Cooperatives, on which the Company bears a 15% residual exposure. The Company's exposure at May 31, 1997, was approximately $4,000,000. Under the Company's borrowing arrangements the maximum amount of the loans outstanding at any one time may not exceed $35,000,000. FEED The Company manufactures and sells feed products and sells feed ingredients, supplements and animal health products under several brand names, including GTA Feeds(R), Norco Feeds, CC Bar Feeds, Let'er Buck Feeds(R) and Pantec(TM). In addition, it provides livestock production services, including customized ration planning, feedstuffs analysis, profit projections, livestock nutritional management, recordkeeping, animal health and environmental engineering and facility management. Sales are made at retail through five retail stores and through Agri-Service Centers and at wholesale to cooperatives (both Affiliated Associations and otherwise) and to other retail farm supply businesses located in Minnesota, North Dakota, South Dakota, Nebraska, Montana, Wyoming, Idaho, Washington and Oregon. Sales of feed for the years ended May 31 are set forth below:
1997 1996 1995 1994 1993 ---- ---- ---- ---- ---- Manufactured feed (tons).... 326,000 351,000 333,000 306,000 301,000
The Company has been able to increase sales and production capacity through several joint venture arrangements entered into in recent years. The decrease in manufactured feed tons from 1996 to 1997 was primarily due to the high cost of feed in relation to the low cattle price, which caused a decline in feed demand. The Company owns nine manufacturing facilities located in Sioux Falls, South Dakota; Great Falls, Montana; Hardin, Montana; Dickinson, North Dakota; Minot, North Dakota; Edgeley, North Dakota; Willmar, Minnesota; Gettysburg, South Dakota; and Norfolk, Nebraska. The Company also has an interest in three joint ventures with facilities in Hermiston, Oregon; Tillamook, Oregon; and Owatonna, Minnesota. The administrative office for the feed business is located in Sioux Falls, South Dakota. The Feed Division's operations reflect the condition of the livestock business. Recent increases in poultry and swine production have been driven by increased exports. The transition from individual producers to more integrated producers has affected the demand for and composition of the Division's products. At May 31, 1997, the Division had 262 full time and 7 part time employees. Competitors in the feed business are other cooperatives and private companies. The Company is a part of the Cooperative Research Farms, a research partnership of 12 regional cooperatives in the United States, Canada and France. This partnership provides the Company with production research. SERVICES The Company's Country Services Division provides certain services to Individual Members and Affiliated Associations. Country Hedging, Inc. Country Hedging, Inc. offers full service commodity futures and options brokerage. For the year ended May 31, 1997, 60% of revenues were from Affiliated Associations, 30% from Individual Members and 10% from others. This separate subsidiary of the Company is a registered futures commission merchant and a clearing member of both the Minneapolis Grain Exchange and the Kansas City Board of Trade. On May 31, 1997, it had 40 employees operating primarily out of St. Paul, Minnesota. Competitors include international brokerage firms, national brokerage firms, regional brokerage firms (both co-op and non-co-op) as well as local introducing brokers. Competition is driven by price and service. Ag States Agency, LLC Ag States Agency, LLC, 50% owned by the Company, is an independent insurance agency which sells insurance primarily to local cooperatives, including group benefits, property and casualty, and bonding programs. For the year ended May 31, 1997, substantially all of its revenues were from local cooperatives. Ag States Agency, LLC competes with other insurance agencies. Financial Services Department The Financial Services Department provides business planning consulting and financing to Affiliated Associations. It offers open account financing, involving the discretionary extension of credit, and term and seasonal loans. Most of the term and seasonal loans are participated up to 90% by National Bank for Cooperatives (CoBank). Participation by CoBank is subject to credit approval on a loan-by-loan basis by CoBank, subject to an overall limit of participation of $150,000,000. In addition to financing, the open account between the Company and an Affiliated Association is used as a clearing account for settlement of grain purchases and as a cash management tool. Open account financing has been provided to more than 200 Affiliated Associations in the past year. During the year ended May 31, 1997, average aggregate loan balances outstanding were $54,013,000 (of which CoBank's participation was $31,651,000) and the highest aggregate loan balance outstanding at any one time was $104,225,000 (of which CoBank's participation was $58,785,000). The Company's borrowing arrangements limit loan balances outstanding to not more than $150,000,000 at any one time. Pursuant to its agreement with CoBank, the Company has additional credit risk on CoBank participations to 10% of total loan commitments. Fin-Ag, Inc., a wholly owned subsidiary of the Company provides certain types of financing to members. See "Farm Marketing and Supply". Affiliated Accounting Department The Affiliated Accounting Department offers computerized country elevator accounting systems and a full complement of accounting support systems for local cooperatives, including tax and patronage allocation services, dividend ledger services and payroll services. For the year ended May 31, 1997, substantially all of its revenues were from local cooperatives. Field Services Department The Field Service Department acts as a liaison between Affiliated Associations and the Company, providing consulting services in marketing, management, operations, accounting, tax, finance and government regulations. Member Relations Department The Member Relations Department conducts cooperative education programs for Affiliated Associations and assists in planning meetings and organizing visits to Company facilities. MEMBERSHIP IN THE COMPANY AND AUTHORIZED CAPITAL Introduction The Company is a membership cooperative organized to manufacture, process, market, purchase, handle, deal in and sell the agricultural products of its members, non-member patrons and others, including the processing and exporting of grain and other agricultural products; to procure supplies and equipment and to perform any and all services for its members, non-member patrons and others; and to engage in any other activity for which cooperative associations may be lawfully organized under Minnesota law. All net savings from member patronage of the Company shall be distributed to members on the basis of patronage. These net savings, when distributed, are referred to as "patronage dividends," regardless of whether distributed in cash or in Patrons' Equities. All net savings from non-member patronage of the purchasing operations and from "Non-Member Consenting Patron" patronage of marketing operations shall be distributed to such patrons on the basis of patronage. The determination of net savings may be made by divisions or units representing separate or different operations of the Company, as determined by the Board of Directors. Patronage refunds may be distributed in cash, written evidences of equity or book credits, or any combination thereof. Any non-cash allocations are redeemable only in the discretion of the Board of Directors. The net earnings (after provision for income taxes) of the Company, as reported in its financial statements for the year, less patronage dividends paid with respect to the fiscal year may be distributed in the discretion of the Board of Directors to member patrons and to non-member "consenting patrons" (defined as cooperative associations meeting all requirements for membership in this Association other than transacting the minimum amount of business) on the basis of their patronage. Distributions may be in cash, property, Non-Patronage Earnings Certificates or any combination thereof designated by the Board of Directors. To date, the Board of Directors has always used Non-Patronage Earnings Certificates for distributions, and the current redemption policy is to redeem to estates. In making any such non-member/non-patronage distributions, the Board of Directors may use any method of allocating the earnings on the basis of patronage to member patrons and Non-Member Consenting Patrons as shall be reasonable and equitable in the judgment of the Board of Directors. The method of allocation for the non-member/non-patronage earnings of the Company for the fiscal year ended May 31, 1997 was based on bushels of the grain marketing/processing activity and dollars on the purchasing and other activity. This method is subject to change, in the discretion of the Board of Directors. Governance The business and affairs of the Company are managed by a Board of Directors of not less than 13 persons (currently set at 14), elected by the members at the Company's annual meeting. Various rights and obligations of members are contained in its Articles of Incorporation and Bylaws (together, the "governing documents"), each of which was amended and restated in November 1996. The governing documents may only be amended upon approval of a majority of the votes cast at an annual or special meeting of the members, except for the higher vote described under "--Certain Antitakeover Effects." Membership Membership in the Company is limited to individuals or entities actually engaged in the production of agricultural products and associations of agricultural producers organized and operating under the provisions of the Agricultural Marketing Act and the Capper-Volstead Act. In addition, only those persons that are "currently active patrons" (defined as agricultural producers and associations of agricultural producers that have patronized the Company during the year for which such status is being determined in a minimum amount established by the Board of Directors) may be members of the Company. Under the Company's governing documents, the Company has several classes of membership and has authority to issue a variety of debt and equity instruments to members. As a membership cooperative, the Company is not authorized to issue capital stock. Under the Minnesota Cooperative Law, under which the Company is organized, a cooperative may be organized on a membership basis or a capital stock basis. A cooperative is organized on a capital stock basis if holding shares of common stock entitles the holder to vote. Membership is transferable only with the consent and approval of the Board of Directors. The Company may issue equity or debt securities, on a patronage basis or otherwise, but unless authorized in, or by the Board of Directors pursuant to, the Company's Bylaws, such securities shall not entitle the holders thereof to any voting, membership or other rights to participate in the affairs of the Company and are not transferable without the prior consent of the Board of Directors. The Company's governing documents establish three classes of membership: Individual Members are individuals or entities actually engaged in the production of agricultural products. Such Individual Members include both natural persons as well as any legal entity owned or controlled by individual farmers or their families, such as joint ventures, corporations, partnerships, limited liability companies and other entities. Affiliated Associations are associations of agricultural producers that have transacted at least $100,000 of business with the Company during the preceding fiscal year. Affiliated Associations must be cooperatives or other associations of agricultural producers organized and operating under the provisions of the Agricultural Marketing Act and the Capper-Volstead Act. Defined Members are either persons actually engaged in the production of agricultural products or associations of producers of agricultural products that are holders of Equity Participation Units. See "--Defined Members" below. Membership in the Company will be terminated by the Board of Directors if a member has become ineligible for membership (for example, by the cessation of agricultural production activities). The Board of Directors has the discretion to terminate membership for a variety of reasons, including repeated violations of the Company's Bylaws, failure to patronize the Company for a period of 12 consecutive months and breach of any contract with the Company. In addition, any member's membership in the Company is terminated when that member either dies or is legally dissolved. Upon termination of membership, a former member loses any and all voting rights in the Company. A former member has no right to require immediate repayment of patronage. Voting Rights Affiliated Associations are entitled to a number of delegates based on the dollar volume of business done with the Company during the last full fiscal year ending prior to the date of the meeting at which the voting power is to be exercised. The number of delegates ranges from one delegate for any Affiliated Association with business from $100,000 up to $1,500,000 during the prior year to 15 delegates for any Affiliated Association with business in excess of $45,000,000 during the prior year. Each delegate from an Affiliated Association is entitled to cast 200 votes on any matter presented to the members for a vote. The dollar volume of business delivered by a Defined Member to an Affiliated Association for handling on behalf of the Company and Defined Member will be included in calculating the dollar volume of an Affiliated Association for purposes of voting. Individual Members and Defined Members are entitled to one vote. Individual Members and Defined Members may directly cast their votes on matters presented to the members of the Company only if, for Defined Members, they have provided notice of such intention to the Company, and, for Individual Members, if they have obtained a certificate signed by a manager of the Company facility patronized by such Individual Member. Any such certificate or notice must be provided to the Company at least 10 days before the meeting at which the voting rights are to be exercised. Individual Members and Defined Members may exercise their voting power through the designation of a "patrons' association." A patrons' association is an association of the Individual Members associated with a grain elevator, feed mill, seed plant or any other Company facility or an association of Defined Members, as designated and recognized by the Board of Directors. The membership of a patrons' association may include both Individual Members and Defined Members. The Individual Members and Defined Members that are identified with a particular patrons' association may, at an annual meeting of the patrons' association, elect delegates and alternates for the patrons' association on the basis of one vote per member. Each patrons' association is entitled to a number of delegates based on the dollar volume of business activities of the patrons' association's currently active patrons and Defined Members with 200 votes per delegate, reduced by the number of individual votes personally voted. Members may cast their votes, if the Board of Directors so elects, by mail voting in certain situations. At least 50 members of the Company represented in person, by delegates or by mail votes constitutes a quorum for business at any meeting, unless the Company has fewer than 500 members, in which case a quorum is comprised of 10% of the total number of members. Defined Members Each Defined Member is affiliated with a "Defined Business Unit" and holds Equity Participation Units in that Defined Business Unit. Holders of Equity Participation Units have delivery rights and obligations for farm products pursuant to a member marketing agreement between such Defined Member and the Company. Each Defined Business Unit is represented by a Defined Member Board, comprised of between five and ten individuals. The members of a Defined Member Board must be either Defined Members or representatives of Defined Members and in good standing and in full compliance with all delivery obligations with respect to the applicable Defined Business Unit, provided, however, no employee of the Company may serve as a member of the Defined Member Board. The initial Defined Member Board of each Defined Business Unit was elected by the Company's Board of Directors in June, 1997. Eight individuals were appointed to serve on the Wheat Milling Defined Member Board, a Chairman plus one member from District 1, three members from District 2, one from District 3, one from District 4 and one from District 5. Six individuals were appointed to serve on the Oilseed Processing and Refining Defined Member Board, a Chairman plus three members from District 1, one member from District 2 and one member from District 3. In November of 1997 the Defined Member Boards of each Defined Business Unit will be elected by the Defined Members associated with the particular Defined Business Unit on a one Defined Member/one vote basis. The Defined Member Boards adopted a Nominating and Election Procedure which has been sent to each Defined Member. In subsequent years, Defined Members will elect members of the Defined Member Boards as their terms expire. The Chairperson is selected by and from the Company's Board of Directors. Individuals serving on a Defined Member Board shall serve staggered three-year terms. Each Defined Member Board shall meet at least quarterly and shall be charged with reflecting Defined Member concerns and providing a direct communication mechanism to the Company's Board of Directors. While the Board of Directors has no present intention of doing so, the Company is authorized to retain a portion of the payments otherwise due to Defined Members for purchases of products from them. Such retention is referred to as a "unit retain." Unit retains would only be established by the Board of Directors to provide a source of cash for its immediate needs and would be limited to a small percentage of the payments due for purchase of products pursuant to the Agreement. The imposition of unit retains would adversely affect a member's cash income and cash position. The Company has the option to treat any such unit retains as taxable to the Company or to treat the unit retains as nontaxable by declaring the unit retains as "qualified." Qualified unit retains are taxable to the Defined Member in the tax year when the Defined Member receives notification that a unit retain has been established. When a qualified unit retain is reimbursed or redeemed, the Defined Member reports no additional income. Unit retains may be called for payout at the lesser of their stated or book value at the discretion of the Board of Directors. The Company intends to establish a redemption schedule if it authorizes unit retains. Debt and Equity Instruments The Company is authorized to issue a variety of debt and equity instruments to its current members, patrons and to persons who are neither members nor patrons. The Company's outstanding capital is represented by Capital Equity Certificates, non-patronage certificates and certain capital reserves. The Company's Bylaws provide the following securities may be issued to current or former members or patrons: Equity Participation Units. Equity Participation Units may be held only by Defined Members and have no voting rights. Defined Members have voting rights to elect a Defined Member Board. Capital Equity Certificates. Capital Equity Certificates may be issued by the Company in partial or complete distribution of patronage refunds. Capital Equity Certificates do not bear any interest or carry any dividends. They do not have a specified maturity date unless established by the Company's Board of Directors. Certificates of Indebtedness. The Board of Directors may issue Certificates of Indebtedness from time to time. Such Certificates will carry such terms and conditions as the Board of Directors establishes in its discretion. The Board may also establish the conditions upon which such Certificates of Indebtedness may be called for payment by the Company. Non-Patronage Earnings Certificates. The Board of Directors may issue Non-Patronage Earnings Certificates. Such certificates will not have a maturity date and will not bear interest or annual dividends. They will be issued and distributed only to member patrons and to Non-Member Consenting Patrons as part of a non-member/non-patronage distribution. (Non-Member Consenting Patrons include Affiliated Associations that meet all of the requirements of membership as an Affiliated Association except that they do not transact at least $100,000 of business with the Company during the preceding fiscal year.) Preferred Capital Certificates. The Board of Directors may establish and designate the designation, preferences and relative rights of one or more series of Preferred Capital Certificates. Preferred Capital Certificates will not carry any voting rights. Other. The Board of Directors may issue other debt or equity instruments. The Bylaws contain no restrictions on the issuance or the terms of such other debt or equity instruments. Voting rights arise by virtue of membership in the Company, not because of holding any instrument. The Board of Directors may issue "Preferred Equities" and other debt or equity instruments to individuals who are not members or patrons of the Company. The Board of Directors has the discretion to establish and designate one or more series of Preferred Equities and to fix the relative rights, preferences and privileges of such Preferred Equities. Any Preferred Equities will not carry voting rights. No such Preferred Equities are presently outstanding, and the Board of Directors has no present plan or intent to issue Preferred Equities. However, if it were to do so, it could establish rights, preferences and privileges relative to the holders of the Units and other securities of the Company. Such preferences could include provisions for priority in payment. The Board of Directors may authorize the issuance of Preferred Capital Certificates pertaining to a particular Defined Business Unit. If such Certificates were issued, they could have a preference in payment over patronage refunds of a particular Business Unit. Transfer of Patrons' Equities. Debt or equity instruments held by the Company's members and patrons, including Equity Participation Units, Capital Equity Certificates, Certificates of Indebtedness, Non-Patronage Earning Certificates and Preferred Capital Certificates, may be transferred only with the consent and approval of the Company's Board of Directors. The Company may require the execution of appropriate transfer documentation, as well as representations and warranties from the proposed transferee indicating that he or she is eligible to be the holder of the instrument proposed to be transferred. Redemption or Retirement of Patrons' Equities and Allocated Reserve. Redemption or retirement of Patrons' Equities is solely within the discretion of and on the terms as determined by the Board of Directors. The Board of Directors has authorized the redemption of Capital Equity Certificates held by patrons who are 72 years of age, as well as Capital Equity Certificates held by estates of deceased patrons. There can be no assurance that the Company's Board of Directors will not elect to modify its policy regarding the redemption of Capital Equity Certificates. The Board is under no restriction in modifying such policy, other than legal agreements to which the Company may be a party from time to time. Members are not required to approve a change in such policy. The Board of Directors will establish a redemption policy for Patrons' Equities arising from Defined Business Units. Distribution of Assets Upon Dissolution Upon dissolution, liquidation or winding up of the Company, all debts and liabilities of the Company will be paid in accordance with their respective priorities. All equity capital will then be allocated among the various holders of the equity instruments in accordance with the following priorities: first, the assets held by any Defined Business Unit will be used to redeem the Equity Participation Units and Preferred Capital Certificates of such Defined Business Unit, on a pro rata basis; next, all Equity Participation Units and Preferred Capital Certificates will be paid to the extent of their face amount or par value; next all Capital Equity Certificates and other outstanding equities (other than Non-Patronage Earnings Certificates) will be paid in the amount of the par value or face amount of such instruments; next, payment will be made in the face amount of any issued and outstanding Non-Patronage Earnings Certificates. Any remaining assets of the Company will be distributed on an allocation unit basis among the members of the Company in proportion to their patronage. Certain Antitakeover Effects The governing documents may be amended upon the approval of a majority of the votes cast at an annual or special meeting. However, in the event that the Board of Directors declares, by resolution adopted by a majority of the Board of Directors present and voting, that the amendment involves or is related to a hostile takeover, the proposed amendment must be adopted by the approval of 80% of the total voting power of the members of the Company. It is within the sole determination of the Board of Directors to declare that a transaction involves a "hostile takeover," which term is not further defined in the Minnesota cooperative law or the governing documents. Tax Treatment Subchapter T of the Internal Revenue Code sets forth rules for the tax treatment of cooperatives and applies to both cooperatives exempt from taxation under Section 521 of the Internal Revenue Code and to nonexempt corporations operating on a cooperative basis. The Company is a nonexempt cooperative. As a cooperative, the Company is not taxed on amounts withheld from its members in the form of qualified unit retains or patronage dividends, or in the amount distributed in the form of patronage payments. Consequently, such amounts are taxed only at the patron level. However, the amounts of any non-qualified unit retains or patronage dividends are taxable to the Company when allocated. Upon redemption of any such non-qualified unit retains or patronage dividends, the amount is deductible to the Company and taxable at the member level. Income derived by the Company from non-patronage sources is not entitled to the "single tax" benefit of Subchapter T and is taxed to the Company at corporate income tax rates. EQUITY PARTICIPATION UNITS Equity Participation Units ("Units") may be held only by Defined Members. Defined Members are either persons actually engaged in the production of agricultural products or associations of producers of agricultural products. Each Defined Member is affiliated with a Defined Business Unit and holds Equity Participation Units in that Defined Business Unit. Holders of Equity Participation Units have delivery rights and obligations for farm products pursuant to the Agreements between such Defined Members and the Company. Each Defined Business Unit and the respective Equity Participation Units were created by resolutions (the "Resolutions") of the Board of Directors, acting pursuant to the governing documents, on January 11, 1997. The terms of the Units are governed by the governing documents and the Resolutions. The Resolutions may be amended by the Board of Directors, except in certain respects, without a vote of holders of the Units. Holders of the Units have the rights and remedies provided by the Minnesota Cooperative Law. Wheat Milling Defined Business Unit Holders of Equity Participation Units in the Wheat Milling Defined Business Unit have a right to participate in the patronage sourced income from the operations of the Wheat Milling Defined Business Unit. Prior to the sale of any Unit to any person, such person entered into an Agreement which gave the right and obligation to such person to deliver the number of bushels of wheat equal to the number of Units purchased by such Member. The delivery obligation and right under the Agreement for the Wheat Milling Defined Business Unit will become fully effective for the fiscal year in which the Pocono facility begins operating. Defined Members will be notified. Until the Agreement becomes fully effective, it will represent a right and obligation to deliver 78% of the wheat set forth therein. Patronage sourced income from the operations of the Wheat Milling Defined Business Unit will be allocated by the Company as patronage refunds based on the total amount of wheat processed. As between the holders of Equity Participation Units, patronage sourced income will be allocated to each Defined Member proportionate to the wheat delivered pursuant to the Agreement. While Defined Members are entitled to the allocation of patronage refunds originating from the Wheat Milling Defined Business Unit, they may also receive, upon allocation by the Board of Directors, nonpatronage income from operations of the Company, including operations of the Wheat Milling Defined Business Unit generating nonpatronage income. Oilseed Processing and Refining Defined Business Unit Holders of Equity Participation Units in the Oilseed Processing and Refining Defined Business Unit have a right to participate in the patronage sourced income from the operations of the Oilseed Processing and Refining Defined Business Unit. Prior to the sale of any Unit to any person, such person entered into an Agreement which gave the right and obligation to such person to deliver the number of bushels of soybeans equal to the number of Unitspurchased by such Member. Patronage sourced income from the operations of the Oilseed Processing and Refining Defined Business Unit, excluding patronage sourced income from the refining of crude oil purchased from others and excluding patronage sourced income from Ventura Foods, will be allocated by the Company as patronage refunds based on the total amount of soybeans processed, giving effect to Units held and Units deemed to be held by the Company. As between the holders of Equity Participation Units, patronage sourced income will be allocated to each Defined Member proportionate to the soybeans delivered pursuant to the Agreement. While Defined Members are entitled to the allocation of patronage refunds originating from the Oilseed Processing and Refining Defined Business Unit, they may also receive, upon allocation by the Board of Directors, nonpatronage income from operations of the Company, including operations of the Oilseed Processing and Refining Defined Business Unit generating nonpatronage income. Allocations Relating to Defined Business Units Revenues from the sale of products of a Defined Business Unit shall be credited to the Defined Business Unit, and all direct expenses incurred by a Defined Business Unit shall be charged against the Defined Business Unit. Corporate, general and administrative expenses of the Company shall be allocated to each Defined Business Unit in a reasonable manner based on the utilization by such Defined Business Unit. Intracompany accounts have been established for the advancements to, and the loan of funds by, each Defined Business Unit, with interest thereon imputed at prevailing rates. Income taxes shall be allocated to each Defined Business Unit as if it were a separate taxpayer. Each Defined Business Unit shall perform and be responsible for commitments, contingencies and obligations allocated to such Defined Business Unit. Patronage sourced income from the operations of a Defined Business Unit (except as set forth above with respect to the Oilseed Processing and Refining Defined Defined Business Unit) will be allocated by the Company as patronage refunds based on the total amount of grain processed, giving effect to Units held and Units deemed to be held by the Company. As between holders of the Units, patronage sourced income will be allocated to each Defined Member proportionate to the number of bushels of grain delivered pursuant to the Agreement. Defined Members may also receive, upon allocation by the Board of Directors, nonpatronage income from operations of the Company, including operations of a Defined Business Unit generating nonpatronage income. With respect to each year, the total net income from a Defined Business Unit will be withdrawn by the Company from the Defined Business Unit, except to the extent that patronage dividends are not paid in cash and are retained in the Business Unit as equity. The Company will be responsible for the allocation of net income arising from operations of a Defined Business Unit between Defined Members of any one or more Defined Business Units and the remainder of the Company's operations. Upon the acquisition by the Company from a third party of any assets (whether by means of an acquisition of assets or stock, merger, consolidation or otherwise) reasonably related to a Defined Business Unit, such assets and related liabilities, including commitments, contingencies and obligations, shall be allocated to that Defined Business Unit and the aggregate cost or fair market value of such assets and liabilities shall be paid by the Defined Business Unit. Such allocation and determination of fair market value may be made by the Board of Directors taking into account such matters as it and its advisers, if any, deem relevant, and any such allocation and determination of fair market value shall be final and binding for all purposes whatsoever. Upon any sale, transfer, assignment or other disposition by the Company of any or all assets of a Defined Business Unit (whether by means of a disposition of assets, merger, consolidation, liquidation or otherwise), all proceeds (including non-cash consideration received) or the fair market value from such disposition shall be allocated to the Defined Business Unit. If an asset is allocated to more than one Defined Business Unit, the proceeds or the fair market value of the disposition shall be allocated among all Defined Business Units, based upon their respective interests in such assets. Such allocation and determination of fair market value shall be made by the Board of Directors taking into account such matters as the Board of Directors and its advisers, if any, deem relevant, and any such allocation and determination of fair market value shall be final and binding for all purposes whatsoever. The Board of Directors may from time to time reallocate any asset from one Defined Business Unit to the Company or any other Defined Business Unit of the Company at fair market value. Such determination of fair market value shall be made by the Board of Directors taking into account such matters as the Board of Directors and its advisers, if any, deem relevant, and any such allocation and determination of fair market value shall be final and binding for all purposes whatsoever. The Company shall not enter into any agreement by which the net patronage sourced earnings of a Defined Business Unit shall be allocated to any person except to a person who owns or is deemed to own Units proportionate to the patronage being so allocated. Additional Equity Participation Units; Sale The Board of Directors from time to time may authorize the sale by the Company of Units deemed owned by the Company for the account of the Company provided that sales shall be at a price determined by the Board of Directors taking into account such matters as the Board of Directors and its financial advisers, if any, deem relevant. The Board of Directors may authorize the creation, issuance and sale of additional Equity Participation Units from time to time on such terms and for such consideration as it shall deem appropriate. Any proceeds from the sale of such additional Equity Participation Units shall be allocated to the applicable Defined Business Unit. There are no limitations on the issuance or sale of additional Units in the governing documents or in any loan agreements or other agreements or instruments to which the Company is a party. Holders of Units shall have no preemptive rights to subscribe for or purchase additional Units or any other securities issued by a Defined Business Unit or the Company. The Company intends to provide an opportunity for existing holders to subscribe for additional Equity Participation Units. The Company may, if authorized by the Board of Directors, purchase Units at such price as it shall determine from time to time for its own account, or for the account of a Defined Business Unit. Merger, Consolidation or Sale In connection with the merger, consolidation, liquidation or sale of all or substantially all of the assets of the Company as an entirety or upon the sale of all or substantially all of the assets of a Defined Business Unit, all, but not less than all, Units of such Defined Business Unit shall be redeemed by the Company at their original purchase price, provided that the Preferred Capital Certificates or unit retains of such Defined Business Unit not previously paid are also redeemed in connection therewith; that such payments include any prorata profit (or loss) associated with disposition of the assets of the Defined Business Unit as though the assets, subject to the liabilities, of the Defined Business Unit had been sold in connection with such event at their fair market value; and that provision is made for the allocations of patronage sourced income arising prior to such transaction. Any determination of fair market value shall be made by the Board of Directors taking into account such matters as the Board of Directors and its advisers, if any, deem relevant. A sale of more than 75% of the assets or earning power will be deemed "all or substantially all" of the assets of the Company or a Defined Business Unit. Operations The operations of a Defined Business Unit shall be carried out by the Company through the Board of Directors, officers and management of the Company. The capital assets of a Defined Business Unit may be disposed of in the ordinary course of business and the disposition of any substantial portion of the assets of a Defined Business Unit as an entirety may be authorized by the Board of Directors. The Board of Directors may determine to sell the assets and operations of a Defined Business Unit or to abandon or shut down the operations of a Defined Business Unit. Abandonment or shutting down the operations of a Defined Business Unit (other than on a temporary basis) will be considered sale of all of the assets of the Defined Business Unit and will have the effect described under "--Merger, Consolidation or Sale." Amendment of Board Resolutions The resolutions adopted by the Board of Directors establishing the Wheat Milling Defined Business Unit and the Oilseed Processing and Refining Defined Business Unit may be amended from time to time by the Board of Directors of the Company, except for those matters described under "Allocations Relating to Business Units" and "Merger, Consolidation or Sale," which may be amended only with the approval of a majority of Defined Members owning Units not held or deemed held by the Company. Member Marketing Agreement A Defined Member will be obligated to deliver during each delivery year one bushel of wheat or soybeans which is of merchantible quality, according to industry standards, to the Company for each applicable Unit held, subject to adjustment as described below, at delivery points designated by the Company; provided, however that, until the Pocono facility commences operation, a Defined Member contracting to deliver wheat shall only have the right and obligation to deliver 78% of the contracted bushels. Wheat or soybeans that do not meet applicable standards may either be rejected or accepted with such discounts as may be established by the Company or agents. Deliveries may be made at any time from June 1 through May 31. Certain Affiliated Associations have contracted with the Company to act as an agent for handling required deliveries (and will receive funds for that service). In addition, the Company has designated most of its owned and operated elevators as delivery points (approx 135). The Board of Directors may establish annual "tolerance ranges" allowing a Defined Member the option to deliver more or less wheat or soybeans in any given year. Upon transfer of Units, the remaining obligations under the Agreement must also be assumed by the transferee of the Units. The Agreement may be terminated by an Individual Member effective on May 31 of any year upon written notice of termination. In addition, the Agreement may be terminated following a breach of the Agreement by either party, upon thirty days' written notice from the party not in breach. The Agreement may be terminated by the Company upon sale, liquidation, dissolution or winding up of the applicable Defined Business Unit in accordance with the Company's Bylaws. The Company is obligated to take and pay for deliveries in accordance with the Agreement. The price to be paid is based on the prevailing price at the point of delivery agreed to between the Defined Member and the Company or its agent at the time of sale. The final settlement price must be established prior to the end of the processing year. In case of fire, explosions, interruption of power, strikes or other labor disturbances, lack of transportation facilities, shortage of labor or supplies, floods, action of the elements, riot, interference of civil or military authorities, enactment of legislation or any unavoidable casualty or cause beyond the control of the Company affecting the conduct of the Company's business to the extent of preventing or unreasonably restricting the receiving, handling, production, marketing or other operations, the Company shall be excused from performance during the period that the Company's business or operations are so affected. The Member shall not be liable for failure or delay in performance of the Agreement to the extent such failure or delay is caused by a crop failure due to an Act of God, such as drought or flood. The Company will pay to each Defined Member an annual patronage refund equal to the portion arising from the net savings of the applicable Defined Business Unit attributable to such Defined Member's patronage of the Defined Business Unit. Each Agreement is subject to amendment upon the approval of the Company and the majority vote of the voting power of the applicable Defined Business Unit. As a result, in the event that Members holding the majority of the voting power of the applicable Defined Business Unit approve an amendment to the Agreement which has been approved by the Company, those Defined Members who voted against or oppose the amendment will be bound to performance of the Agreement as amended. Upon the termination of the operations of a Defined Business Unit, the Marketing Agreement will automatically terminate. The Company is authorized to retain a portion of the payments otherwise due to Defined Members for purchases of products from them. Such retention is referred to as a "unit retain." The Company has the option to treat any such unit retains as taxable to the Company or to treat the unit retains as nontaxable by declaring the unit retains as "qualified." Qualified unit retains are taxable to the Defined Member in the tax year when the Defined Member receives notification that a unit retain has been established. When a qualified unit retain is reimbursed or redeemed, the Defined Member reports no additional income. Unit retains may be called for payout at the lesser of their stated or book value at the discretion of the Board of Directors. Taxation Patronage dividends arising under the Agreements with respect to the Units will have the same tax treatment as patronage currently payable to members. Transfer of Equity Participation Units Upon any transfer of Units, the transferee will be required to certify as to eligibility and then current anticipated annual production and to sign an Agreement. In approving any transfer, the Board of Directors will require that such certificate show that the number of Units transferred does not exceed anticipated annual production, that any transferee does not own more than 1% of the outstanding capacity of any one Defined Business Unit and that the Units held by each transferor retaining units and transferee represent at least 3,000 bushels of wheat or 1,500 bushels of soybeans. ITEM 2. PROPERTIES The Company owns or leases grain handling and processing facilities throughout the United States. Below is a summary of these locations. Grain Merchandising The Company owns or leases grain terminals at the following locations: Davenport, Iowa I (1) Davenport, Iowa II (2) Kalama, Washington (2) Kansas City, Missouri I (2) Kansas City, Missouri II (2) Kennewick, Washington (1) Myrtle Grove, Louisiana (1) Petersburg, North Dakota (2) St. Paul, Minnesota (2) Savage, Minnesota (1) Spokane, Washington (1) Superior, Wisconsin (1) - ---------------------- (1) Owned (2) Leased Oilseed Processing and Refining The Oilseed Processing and Refining Defined Business Unit owns one facility in Mankato, Minnesota, comprised of a crushing plant, a refinery, a soyflour plant, and a quality control laboratory. Wheat Milling The Wheat Milling Defined Business Unit owns or leases flour milling facilities at the following locations: Rush City, MN (1) 10,000 cwts/day Huron, OH (3) 14,500 cwts/day Kenosha, WI (1) 21,000 cwts/day Houston, TX (1) 13,000 cwts/day - ------------------------ (1) Owned (2) Leased (3) Owned equipment, leased land and facilities Agri Services Centers The Company owns 154 Agri Service Centers (of which some of the facilities are on leased land) located in Minnesota, North Dakota, South Dakota and Montana. Feed The Company owns the following feed manufacturing facilities: Dickinson, North Dakota Edgeley, North Dakota Gettysburg, South Dakota Great Falls, Montana Hardin, Montana Minot, North Dakota Norfolk, Nebraska Sioux Falls, South Dakota Willmar, Minnesota ITEM 3. LEGAL PROCEEDINGS The Company is a party to various lawsuits and administrative proceedings incidental to its business. It is impossible at this time, to estimate what the ultimate legal and financial liability of the Company will be; nevertheless, management believes, based on the information available to date and the resolution of prior proceedings, that the ultimate liability of all litigation and proceedings will not have a material impact on the financial statements of the Company taken as a whole. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS No matter was submitted to a vote of security holders during the fourth quarter of the year ended May 31, 1997. PART II. ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS No equity securities were sold by the Registrant during the year ended May 31, 1997, that were not registered under the Securities Act of 1933, as amended. ITEM 6. SELECTED FINANCIAL DATA Consolidated Company The selected financial information below has been derived from the Company's consolidated financial statements for the years ended May 31, 1997, 1996, 1995, 1994, and 1993, which have been audited by Deloitte & Touche LLP, independent auditors. The selected consolidated financial information should be read in conjunction with the Company's consolidated financial statements and notes thereto included elsewhere in this filing. Summary Consolidated Financial Data
Years Ended May 31, ---------------------------------------------------------------------------------- 1997 1996 1995 1994 1993 -------------- -------------- -------------- -------------- -------------- Income Statement Data: Revenues Sales: Grain ............................. $6,036,502,624 $7,127,223,407 $4,191,665,535 $3,086,531,429 $2,793,407,187 Processed grain ............................ 730,101,124 819,863,541 708,219,307 593,116,553 501,297,427 Feed and farm supplies ......................... 258,235,512 207,252,696 156,699,068 165,925,459 138,103,158 -------------- -------------- -------------- -------------- -------------- 7,024,839,260 8,154,339,644 5,056,583,910 3,845,573,441 3,432,807,772 Patronage dividends ......................... 15,947,049 13,278,997 6,512,481 6,609,602 7,781,622 Other revenues ..................... 68,627,552 68,339,523 57,556,984 45,895,922 41,671,562 -------------- -------------- -------------- -------------- -------------- 7,109,413,861 8,235,958,164 5,120,653,375 3,898,078,965 3,482,260,956 Costs and expenses: Cost of goods sold .............................. 6,967,937,476 8,076,073,326 4,981,820,272 3,786,336,764 3,384,637,000 Marketing, general, and admin- istrative ......................... 63,341,552 70,054,248 69,509,491 60,847,099 52,545,022 Interest ........................... 19,378,833 31,921,936 19,268,575 10,250,765 8,964,230 -------------- -------------- -------------- -------------- -------------- 7,050,657,861 8,178,049,510 5,070,598,338 3,857,434,628 3,446,146,252 -------------- -------------- -------------- -------------- -------------- Earnings before income taxes ....................... 58,756,000 57,908,654 50,055,037 40,644,337 36,114,704 Income taxes ......................... 6,200,000 6,900,000 5,100,000 5,500,000 3,725,000 -------------- -------------- -------------- -------------- -------------- Net earnings ......................... $ 52,556,000 $ 51,008,654 $ 44,955,037 $ 35,144,337 $ 32,389,704 ============== ============== ============== ============== ============== May 31, ---------------------------------------------------------------------------------- 1997 1996 1995 1994 1993 -------------- -------------- -------------- -------------- -------------- Balance Sheet Data (at end of period): Working capital .................... $ 111,811,047 $ 95,874,938 $ 66,904,085 $ 69,409,621 $ 69,550,702 Net property, plant and equipment ..................... 224,150,965 232,145,401 205,837,690 156,311,551 146,223,870 Total assets ....................... 976,705,753 1,228,772,684 924,533,569 734,655,223 612,261,778 Long-term debt, including current maturities ........................ 134,458,466 132,629,176 84,816,525 39,135,097 44,479,207 Total equity ....................... 385,099,313 337,252,119 299,487,893 270,761,017 246,797,147
Oilseed Processing and Refining Defined Business Unit The selected financial information presented below has been derived from the Oilseed Processing and Refining Defined Business Unit's financial statements for the years ended May 31, 1997, 1996, 1995 and 1994, which have been audited by Deloitte & Touche LLP, independent auditors. The selected financial information should be read in conjunction with the Defined Business Unit's financial statements and notes thereto included elsewhere in this filing.
Years Ended May 31, ------------------- 1997 1996 1995 1994 ------------- ------------- ------------- -------------- Revenues: Processed Oilseed Sales ............ $ 441,737,923 $ 399,271,001 $ 398,095,108 $ 358,372,039 Other revenues ..................... (1,659,881) 1,435,708 1,162,518 1,349,484 ------------- ------------- ------------- -------------- 440,078,042 400,706,709 399,257,626 359,721,523 Costs and expenses Cost of goods sold ................. 405,791,384 371,424,566 366,407,451 334,968,474 Marketing and administrative ................... 4,341,904 4,544,763 5,137,663 4,722,900 Interest ........................... 321,700 151,500 -- 164,300 ------------- ------------- ------------- -------------- .......................... 410,454,988 376,120,829 371,545,114 339,855,674 ------------- ------------- ------------- -------------- Earnings before income taxes .............................. 29,623,054 24,585,880 27,712,512 19,865,849 Income taxes ......................... 2,100,000 1,600,000 1,500,000 1,650,000 ------------- ------------- ------------- -------------- Net earnings ......................... $ 27,523,054 $ 22,985,880 $ 26,212,512 $ 18,215,849 ============= ============= ============= ============== Operating Data: Quantities processed Soybeans (bu.) ................... 32,231,520 30,446,475 30,807,933 24,136,364 Crude oil (lb.) .................. 960,406,920 920,492,402 894,970,248 860,221,089 Production Meal (tons) ...................... 741,922 728,435 741,190 588,873 Flour (tons) ..................... 35,714 39,914 40,614 31,614 Refined oil (lbs.) ............... 957,398,000 858,240,000 835,396,000 799,908,000 1997 1996 1995 1994 ------------- ------------- ------------- -------------- Balance Sheet Data (at end of period): Working capital .................... $ 20,305,438 $ 28,619,585 $ 32,980,590 $ 33,813,064 Net property, plant and equipment .................... 33,085,560 24,771,413 20,410,408 19,577,934 Total assets ....................... 92,416,098 74,112,937 63,672,994 74,191,110 Long-term debt, including current maturities ............... -- -- -- -- Total equity ................ 53,390,998 53,390,998 53,390,998 53,390,998 Other Data (1): Pretax earnings .................... $ 29,623,054 $ 24,585,880 $ 27,712,512 $ 19,865,849 Earnings from purchased oil ........ (7,014,758) (3,557,406) (4,680,813) (4,511,979) Non-patronage joint venture income ............................ (614,967) (1,353,708) (990,191) (1,300,427) Book to tax differences ............ 2,209,575 (71,485) 393,608 135,170 ------------- ------------- ------------- -------------- Tax basis soybean earnings ......... $ 24,202,904 $ 19,603,281 $ 22,435,116 $ 14,188,613 ============= ============= ============= ============== Bushels processed .................. 32,231,520 30,466,475 30,807,933 22,630,472 Earnings per bushel ................ $ 0.75 $ 0.64 $ 0.73 $ 0.63
Pro Forma Information (2) Year Ended May 31, 1997 ----------- Equity Participation Units Outstanding 1,074,000 Patronage rate $ 0.75 ----------- Earnings to holders $ 805,500 =========== (1) Because patronage dividends attributable to the Units will be allocated based on the number of bushels of soybeans delivered, information on earnings per bushel is believed by the Company to be the most relevant indicator of performance of the Oilseed Processing and Refining Defined Business Unit. (2) Based upon the actual number of Equity Participation Units outstanding on May 31, 1997, the earnings of the Oilseed Processing and Refining Defined Business Unit which would have been allocated to the Equity Participation Units are shown above under the caption "Pro Forma Information". Wheat Milling Defined Business Unit The selected financial information presented below has been derived from the Wheat Milling Defined Business Unit's financial statements for the years ended May 31, 1997, 1996, 1995 and 1994, which have been audited by Deloitte & Touche LLP, independent auditors. The selected financial information should be read in conjunction with the Defined Business Unit's financial statements and notes thereto included elsewhere in this filing.
Years Ended May 31, ------------------- 1997 1996 1995 1994 ------------- ------------- ------------- ------------- Revenues: Sales .............................. $ 199,078,687 $ 173,315,613 $ 119,725,183 $ 103,716,012 Costs and expenses: Cost of goods sold ................. 181,565,899 161,293,430 112,690,679 97,206,374 Marketing and administrative ................... 6,749,237 4,471,563 3,834,289 2,415,155 Interest ........................... 5,229,669 4,457,797 2,278,544 1,832,037 Other .............................. 2,000,000 ------------- ------------- ------------- ------------- 195,544,805 170,222,790 118,803,512 101,453,566 Earnings before income: taxes .............................. 3,533,882 3,092,823 921,671 2,262,446 Income taxes ......................... 300,000 200,000 125,000 150,000 ------------- ------------- ------------- ------------- Net earnings ......................... $ 3,233,882 $ 2,892,823 $ 796,671 $ 2,112,446 ============= ============= ============= ============= Operating Data: Wheat used (bu.) Durum ............................ 21,372,000 19,376,000 16,058,000 15,763,000 Spring .......................... 6,732,000 3,013,000 1,638,000 1,167,000 Shipments (cwt) Semolina/flour ................... 11,168,000 10,085,000 8,718,000 8,088,000 Baking flour ..................... 2,599,000 634,000 -- -- 1997 1996 1995 1994 ------------- ------------- ------------- ------------- Balance Sheet Data (at end of period): Working capital .................... $ (1,938,733) $ 3,338,206 $ 1,604,146 $ (4,703,152) Net property and equipment ........................ 69,130,520 59,233,046 43,395,670 19,739,029 Total assets ....................... 120,918,192 125,321,564 82,606,055 55,031,562 Long-term debt, including current maturities ............... 61,214,270 54,000,000 33,750,000 19,000,000 Total equity ....................... 27,797,072 27,797,072 27,797,072 27,797,072 Other Data (1): Pretax earnings .................... $ 3,533,882 $ 3,092,823 $ 921,671 $ 2,262,446 Book to tax differences ............ 2,375,920 (84,481) 123,844 (135,715) ------------- ------------- ------------- ------------- Tax basis earnings ................. $ 5,909,802 $ 3,008,342 $ 1,045,515 $ 2,126,731 ============= ============= ============= ============= Bushels milled ..................... 28,103,677 22,390,011 17,696,689 16,930,702 ============= ============= ============= ============= Earnings per bushel ................ $ 0.21 $ 0.13 $ 0.06 $ 0.13
Pro Forma Information (2) Year Ended May 31, 1997 ----------- Equity Participation Units Outstanding 4,787,000 Patronage rate $ 0.21 ----------- Earnings to holders $ 1,005,270 =========== (1) Because patronage dividends attributable to the Units will be allocated based on the number of bushels of wheat delivered, information on earnings per bushel is believed by the Company to be the most relevant indicator of performance of the Wheat Milling Defined Business Unit. (2) Based upon the actual number of Equity Participation Units outstanding on May 31, 1997, the earnings of the Wheat Milling Defined Business Unit which would have been allocated to the Equity Participation Units are shown above under the caption "Pro Forma Information". ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION Consolidated Company Results of Operations Comparison of Year Ended May 31, 1997 with 1996 The Company's consolidated net earnings of approximately $52,600,000 for the year ended May 31, 1997 represents a $1,600,000 (3%) increase from 1996. This increase is primarily attributable to improved gross margins and expanded volume for refined oil products within the Company's Oilseed Processing and Refining Defined Business Unit. Consolidated net sales of $7,025,000,000 in 1997 decreased $1,129,000,000 (14%). This decrease was due primarily to reduced grain volume of 400 million bushels, from 1.7 billion bushels in 1996 to 1.3 billion bushels in 1997. The reduced sales volume was partially offset by an increase in grain price as a weighted average of all commodities sold which was 68 cents per bushel greater in 1997 compared to 1996. Patronage dividends increased $2,600,000 (20%) in 1997 compared to 1996 resulting from higher patronage earnings distributed by cooperative customers and suppliers. Other revenue of $68,600,000 was essentially unchanged in total from 1996, although there were significant changes in the components of this category. Service revenues increased $6,800,000 in 1997, primarily because the Myrtle Grove, LA export terminal was operated as part of the Company's consolidated operations, whereas a year ago this facility operated as part of a nonconsolidated joint venture. Expansion of the Company's fertilizer and chemical application services contributed an additional $5,000,000 over the prior year. These increases in revenue were offset by a net change in gains and losses on disposal of fixed assets of $5,500,000 which includes a reserve for the impairment of value of the Rush City, MN mill of $2,000,000, a decline of $2,100,000 in interest income and net decreases in several other revenue categories of $4,500,000. Cost of goods sold of $6,968,000,000 decreased $1,108,000,000 (14%) in 1997. This decrease is primarily attributable to the decline in bushel volume of approximately 400 million bushels, partially offset by an increase in the weighted average cost of commodities from $4.16 per bushel in 1996 to $4.84 per bushel in 1997. Marketing and administrative costs of $63,300,000 declined $6,800,000 (10%) in 1997. The primary cause for this decrease is the elimination of such costs related to the Consumer Products and Packaging Division of the Company which was transferred to a nonconsolidated joint venture on August 30, 1996. This transaction reduced such costs $9,000,000 in 1997. Interest expense of $19,400,000 decreased $12,500,000 (39%) in 1997. $14,600,000 of this decrease is substantially attributable to the grain volume, grain price situation described in the discussion on cost of goods sold, which produced lower inventory and receivable levels. This short-term interest reduction was partially offset in the amount of $2,100,000 of additional long-term interest expense, incurred primarily to finance property, plant and equipment. Income tax expense of $6,200,000 and $6,900,000 for 1997 and 1996, respectively, results in effective tax rates of 10.5% and 11.9%. This decrease in the effective tax rate is primarily attributable to an increase in patronage earnings as a percentage of total pretax earnings. Comparison of Year Ended May 31, 1996 with 1995 Consolidated net earnings of approximately $51,000,000 for the year ended May 31, 1996 is a $6,000,000 increase from 1995. This increase is attributed primarily to increased volumes of grain handled and increased returns on investments. Consolidated net sales of $8,154,000,000 in 1996 increased by $3,097,000,000 (61%). This increase was due principally to grain volume of 1.7 billion bushels in 1996, an increase of 550 million bushels over 1995 and an increase in grain price as a weighted average of all commodities sold which was $4.21 for 1996, 56 cents per bushel greater than 1995. Patronage dividends increased $6,800,000 (105%) in 1996 compared to 1995 resulting from higher patronage earnings distributed by cooperative customers and suppliers. Other revenues of $68,300,000 increased $10,700,000 (19%) in 1996. This net increase was due primarily to an increase of $4,600,000 in service revenues, from the Company's export facilities, and an increase in joint venture income of $8,500,000, primarily from those joint ventures involved in the exporting of grain, net of a $2,400,000 decrease in all other categories of other revenues, including the write-down of investments totaling $1,100,000. Cost of goods sold of $8,076,000,000 increased $3,094,000,000 (62%) in 1996. This increase is attributable primarily to an increase in the weighted average cost of commodities of $4.16 in 1996 from $3.59 in 1995. Marketing and administrative expenses were essentially flat compared to 1995. An expansion of the relative size of the Company's operations, which increased costs in certain areas, was offset by a decrease in pension costs of $4,000,000, principally caused by a settlement adjustment recognized in 1995. Interest expense of $31,900,000 increased $12,600,000 (65%) in 1996. This increase is substantially attributable to a $10,300,000 increase in interest on short-term debt incurred to finance increased volumes at higher prices and an increase of $3,200,000 in interest on long-term debt incurred primarily for the expansion of property, plant, and equipment. Income tax expense of $6,900,000 and $5,100,000 for 1996 and 1995, respectively, results in effective tax rates of 11.9% and 10.2%. The increase in the effective tax rate is primarily attributable to an increase in non-patronage income during 1996. Liquidity and Capital Resources Cash Flows from Operations Operating activities of the Company provided net cash of $271,600,000 for the year ended May 31, 1997, and used net cash of $105,700,000 and $49,700,000 for the years ended in 1996 and 1995, respectively. Net cash provided and used by operations is primarily attributable to changes in working capital requirements with such balances decreasing $216,600,000 in 1997 and thereby contributing cash, and increasing $154,200,000 and $103,700,000 in 1996 and 1995, respectively, thereby using net cash. Cash Flows from Investing For the years ended May 31, 1997, 1996, and 1995, the net cash flows used in the Company's investing activities totaled $19,800,000, $37,600,000 and $71,400,000, respectively. The acquisition of property, plant and equipment comprised the primary use of cash in each of the three years, totaling $42,400,000, $40,500,000, and $69,300,000 in 1997, 1996 and 1995, respectively. Capital expenditures for fiscal year 1998 are expected to be $73,400,000. In the year ended May 31, 1997, the Company received net cash from the distribution of investments held in other cooperatives and joint ventures totaling $20,600,000, which partially offset the cash used for capital expenditures in that year. On August 30, 1996 the Company formed a joint venture with a regional consumer products packaging company, and contributed substantially all of the net assets of the Consumer Products Packaging Division as its capital investment in that joint venture. In return for these assets, the Company received a 40% interest in the joint venture and the joint venture assumed debt of approximately $33,700,000. Cash Flows from Financing The Company finances its working capital needs through short-term lines of credit with the banks for cooperatives and commercial banks. As of May 31, 1997 the Company had short-term lines of credit totaling $550,000,000, all of which is committed, and $98,000,000 was outstanding. For the year ended May 31, 1997, the Company decreased its outstanding seasonal borrowings by $226,000,000, corresponding with the decrease in working capital requirements created primarily by a decline in inventory and accounts receivable levels. For the years ended May 31, 1996 and 1995, the Company increased outstanding seasonal borrowings by $124,000,000 and $87,000,000, respectively, in order to fund the working capital needs caused by the increase in grain volumes during those two years. The Company has financed its long-term capital needs, primarily for the acquisition of property, plant, and equipment, with long-term agreements through the banks for cooperatives with maturities through the year 2007. Total indebtedness of these agreements totaled $125,000,000 and $120,700,000 on May 31, 1997 and 1996, respectively. The Company also had long-term debt in the form of capital leases, industrial development revenue bonds and miscellaneous notes payable totaling approximately $9,500,000 and $11,900,000 on May 31, 1997 and 1996, respectively. The Company borrowed on a long-term basis $18,800,000, $58,000,000 and $51,000,000, and repaid long-term debt in the amounts of $17,400,000, $11,300,000 and $5,900,000 in 1997, 1996 and 1995, respectively. The Company anticipates further short-term financing needs to fund increases in the volume of grain handled and further long-term needs to fund acquisitions of grain facilities and for the expansion and development of existing value-added businesses. Management believes such needs can be financed with a combination of debt and equity. In accordance with the bylaws and action of the Board of Directors, annual net earnings form patronage sources are distributed to consenting patrons following the close of each year and are based on amounts reportable for federal income tax purposes as adjusted in accordance with the bylaws. The cash portion of this distribution, deemed by the Board of Directors to be 30% of such earnings for fiscal years 1996, 1995, and 1994 distributed in 1997, 1996 and 1995, respectively, totaled $13,200,000, $11,000,000 and $10,000,000. Cash patronage for fiscal year 1997, to be distributed in fiscal year 1998, is expected to be approximately $13,200,000 and is classified as a current liability on the May 31, 1997 balance sheet. The Board of Directors authorized the redemption of patronage certificates held by patrons who were 72 years of age and those held by estates of deceased patrons during the years ended May 31, 1997, 1996 and 1995. These amounts totaled $8,200,000, $6,600,000 and $5,700,000, respectively. During the year ended May 31, 1997, the Company offered securities in the form of Equity Participation Units in its Wheat Milling and Oilseed Processing and Refining Defined Business Units. These Equity Participation Units give the holder the right and obligation to deliver to the Company a stated number of bushels in return for a prorata share of the undiluted grain based patronage earnings of these respective Defined Business Units. The offering resulted in the issuance of such equity with a stated value of $13,870,000 and generated additional capital and cash of $10,837,000, after issuance cost and conversion privileges. Conversion privileges allowed a member to elect to use outstanding patrons'equities for the payment of up to one-sixth the purchase price of the Equity Participation Units. Holders of the Units will not be entitled to payment of dividends by virtue of holding such Units. However, holders of the Units will be entitled to receive patronage refunds attributable to the patronage sourced income from operations of the applicable Defined Business Unit on the basis of wheat or soybeans delivered pursuant to the Member Marketing Agreement. The Board of Directors' goal is to distribute patronage refunds attributable to the Units in the form of 75% cash and 25% Patrons' Equities, and to retire those Patron Equities on a revolving basis seven years after declaration. However, the decision as to the percentage of cash patronage will be made each fiscal year by the Board of Directors and will depend upon the cash and capital needs of the respective Defined Business Units and is subject to the discretion of the Board of Directors. The redemption policy will also be subject to change at the discretion of the Board of Directors. Oilseed Processing and Refining Defined Business Unit Certain events and circumstances of which management has become aware during or after the year ended May 31, 1997 which could negatively impact future earnings and liquidity include the following: The Oilseed Processing and Refining Defined Business Unit has conducted facility maintenance and new equipment installation during the first quarter of fiscal 1998 (the first quarter of fiscal 1998 is June 1,1997 through August 31, 1997), which resulted in the disruption of production at the crushing portion of the business and will have a negative impact on earnings for the period, the extent of which is unknown at this time. Results of Operations Certain operating information pertaining to the Oilseed Processing and Refining Defined Business Unit is set forth below, as a percentage of sales, except processing margins. Years Ended May 31, ------------------- 1997 1996 1995 1994 ---- ---- ---- ---- Gross margin percentage ..... 7.76% 7.33% 8.25% 6.91% Marketing and administrative . .98% 1.14% 1.29% 1.32% Interest ......... 0.07% 0.04% -- 0.05% Processing margins Crushing/bu .... $ .59 $ .60 $ .59 $ .50 Refining/lb .... $.0173 $.0154 $.0149 $.0132 Because of the volatility of commodity prices, the Company believes that processing margins are a better measure of the Defined Business Unit's performance than gross margin percentages. Comparison of Year Ended May 31, 1997 with 1996 The Oilseed Processing and Refining Defined Business Unit's net earnings of $27,500,000 for the year ended May 31, 1997 represents a $4,500,000 increase (20%) compared to the same period in 1996. This increase is primarily attributable to improved gross margins for refined oil products due to increased demand. Net sales of $441,700,000 for the year ended May 31, 1997 increased by $42,400,000 (11%) compared to the same period in 1996. Volume increases in processed soybean products, primarily soymeal and soyflour, contributed $8,300,000 to sales and increased volumes of refined oil contributed $11,100,000. Increased sales prices for soymeal and soyflour contributed $44,900,000, offset by a decline in the sales prices for refined oil which reduced total sales by $21,900,000. Other revenues declined $3,100,000 for the year ended May 31, 1997 compared to 1996, primarily because of a loss of $2,000,000 on equipment to be replaced as part of plant expansion and renovation during the summer of 1997, a writedown of an investment of $250,000 and a reduction of income from an oilseed joint venture of about $800,000. Cost of goods sold for the year ended May 31, 1997 of $405,800,000 increased $34,400,000 (9%) compared to the year ended May 31, 1996. This increase is primarily attributable to higher prices for soybeans partially offset by a price decrease in purchased crude oil, and a reduction in plant operating expenses of $1,700,000. Marketing and administrative expenses declined $200,000 (4%) for the year ended May 31, 1997 compared to 1996. Interest expense increased approximately $170,000 (113%) for the year ended May 31, 1997 compared to 1996. This increase is attributable primarily to increased cost of soybeans compared to 1996, and the capital expenditures of 1997. Income tax expense of $2,100,000 and $1,600,000 for 1997 and 1996, respectively, results in effective tax rates of 7.1% and 6.5%. This increase in the effective tax rate is the result of a higher percentage of nonpatronage income for the Defined Business Unit in 1997. Comparison of Year Ended May 31, 1996 with 1995 The Oilseed Processing and Refining Defined Business Unit's net earnings of $23,000,000 for the year ended May 31, 1996 is a $3,200,000 decrease in net earnings from the prior year. This decrease in net earnings is attributable to an increase in cost of goods sold which could not entirely be passed on to the customer due to competitive industry conditions. Net sales of $399,300,000 increased by $1,200,000 in 1996 compared to 1995. Product volume increases, particularly refined oil, contributed $6,800,000 in additional sales, offset by a decline in overall average sale prices which decreased net sales by $5,600,000. Other revenues of $1,400,000 increased $200,000 (17%) compared to 1995. This net increase was primarily attributed to an increase in income from an oilseed joint venture. Cost of goods sold of $371,400,000 in 1996 increased $5,000,000 (1.4%) compared to 1995. Of this increase, $2,700,000 is due to increased volume of production and $2,500,000 is due to increased prices of soybeans and crude soybean oil. Plant expenses decreased by $200,000. While the cost of raw materials (soybeans and soybean crude oil) increased during the year on a per unit basis, the average sales price for products declined because of an overall increase in production in the industry. The increase in raw material costs could not be passed on in the form of higher sales prices because of this competitive environment and is the primary cause for the decline in gross margins and net earnings in 1996 when compared to 1995. Marketing and administrative expenses declined by $600,000 in 1996. This decrease largely results from additional pension expense of $600,000 in 1995 related to a benefit plan settlement adjustment which was allocated to all Harvest States divisions. The Defined Business Unit incurred interest expense of $152,000 in 1996 while in 1995 it incurred no such expense. This increase is attributable to increased working capital requirements caused primarily by comparatively higher inventory values caused by higher soybean and soybean oil prices and fixed asset additions of $6,000,000 in 1996 which were partially financed by borrowings. Income tax expense of $1,600,000 and $1,500,000 for 1996 and 1995, respectively, results in effective tax rates of 6.5% and 5.4%. The increase in the effective tax rate is the result of a higher percentage nonpatronage income for the Defined Business Unit in 1996. Liquidity and Capital Resources The Oilseed Processing and Refining Defined Business Unit's cash requirements result from capital improvements and from a need to finance additional inventories and receivables based on increased raw material costs or levels. These cash needs are expected to be fulfilled by the Company. Cash Flows from Operations Operating activities for the years ended May 31, 1997, 1996 and 1995 provided cash of $23,600,000, $14,400,000, and $44,900,000, respectively. Net earnings of $27,500,000, $23,000,000, and $26,200,000 in 1997, 1996 and 1995, respectively, were offset by an increase in working capital requirements in 1997 of $7,800,000, and in 1996 of $10,200,000. In 1995, a decrease in working capital requirements of $16,900,000 contributed cash. Cash Flows Used for Investing Net cash flows used in the Oilseed Processing and Refining Defined Business Unit's investing activities for the years ended May 31, 1997, 1996 and 1995 were $12,100,000, $6,000,000, and $2,600,000, respectively. Essentially all of these cash usages were for the acquisition of property, plant and equipment. Capital expenditures for fiscal year 1998 are expected to be $18,600,000. Cash Flows from Financing Activities The Defined Business Unit's financing activities are coordinated through the Company's cash management department. Cash from all of the Company's operations is deposited with the Company's cash management department and disbursements are made centrally. As a result, the Defined Business Unit has a zero cash position. Financing is available from the Company to the extent of the Company's working capital position and corporate loan agreements with various banks, and cash requirements of all other Company operations. Working capital requirements for a Defined Business Unit are reviewed on a periodic basis, and could potentially be restricted based upon management's evaluation of the prevailing business conditions and availability of funds. Debt outstanding and payable to the Company as of May 31, 1997 and 1996 was $25,600,000 and $9,500,000, respectively. These interest bearing balances reflect working capital and fixed asset financing requirements at the end of the respective years. Wheat Milling Defined Business Unit Certain events and circumstances of which management has become aware of during or after the year ended May 31, 1997 which could negatively impact future earnings and liquidity include the following: In March 1997, it was reported that Borden (which represented 23.0% and 23.8% of the Wheat Milling Defined Business Unit's semolina and durum flour sales in the years ended May 31, 1997 and 1996, respectively) was closing five of its ten North American pasta manufacturing plants. Four of the plants to be closed are customers of the Wheat Milling Defined Business Unit. Since that time, one of the five plants scheduled for closure has in fact closed; the other four plants have continued to operate at reduced volumes, apparently in anticipation of closure or divestiture by Borden. A substantial portion (44.4% and 31.5% for 1997 and 1996, respectively) of the production of the Company's Rush City facility has in the past been sold to the two Minnesota plants (until recently, owned by Borden) currently operating at reduced volumes. Because of this reduced demand from the Borden plants and because there are no other large pasta manufacturing plants located in geographical proximity to Rush City, the Company elected to close the Rush City facility in late May 1997 and throughout the month of June. In early July 1997, the Company reopened the facility and has operated one milling line to provide durum flour to other customers. During the month of July 1997, the Rush City mill operated at approximately one-third of its normal production volumes. The Company continued to provide a portion of the Borden plant's semolina requirements from its Kenosha mill. The continuation of that business both in terms of volume and duration is uncertain. It has been reported that Borden has sold its Minnesota pasta plants to an employee/investor group. A high degree of uncertainty will continue to exist regarding the level of semolina demand required by the new company, and consequently, the level of production at which the Rush City mill will operate into the future. Although the Company is unable to predict the precise effect on its operations which will result from closure or sale of the Borden plants, it has determined that whatever the eventual resolution, the impact is likely to be negative on its Rush City mill. Consequently, the Company has assessed the carrying value of the Rush City mill relative to expected future cash flows and has recognized a $2,000,000 charge to continuing operations for the year ended May 31, 1997 as a result of the impaired value of this facility. The Company may elect to sell the Rush City facility, close the facility, or operate at reduced capacity, depending upon the opportunities offered by the market place. While a March 1997 mill start-up had been anticipated for the Houston mill, equipment installation delays resulted in the mill's production not starting until June 1997. Currently the facility's volume of bulk flour shipments is less than 50% of its 14,000 cwt. per day capacity. As the customer base grows, and with the recently completed installation of an automated flour packaging line for domestic and export flour, it is expected that the mill will be at full capacity by December 1997. Results of Operations Certain operating information pertaining to the Defined Business Unit is set forth below, as a percentage of sales, except for margins/cwt. Years Ended May 31, ------------------- 1997 1996 1995 1994 ---- ---- ---- ---- Gross margin percentage ....... 8.80% 6.94% 5.88% 6.28% Marketing and administrative ... 3.39% 2.58% 3.20% 2.33% Interest ........... 2.63% 2.57% 1.90% 1.80% Margins/cwt ........ $ 1.27 $ 1.12 $.81 $ .80 Because of the volatility of commodity prices, the Company believes that margins per hundred weight (manufacturing margins) are a better measure of the Defined Business Unit's performance than gross margin percentages. Comparison of Year Ended May 31, 1997 with 1996 The Defined Business Unit's net earnings of $3,200,000 for the year ended May 31, 1997 increased $300,000 (10%) over 1996. This increase in net earnings is attributable primarily to higher volumes of production at improved gross margins for flour products, offset by a $2,000,000 loss on the impairment of fixed asset value at the Rush City, Minnesota mill. Because of the uncertainty of future business volumes and margins to be generated by this mill, management assessed the carrying value of these assets against projected cash flows and recognized the resulting loss in conformity with Statement of Financial Accounting Standards (SFAS) No. 121. Net sales for the year ended May 31, 1997 of $199,100,000 increased $25,800,000 (15%) from 1996. This increase is primarily the result of an increase in total volume of product sold, partially offset by an overall reduction in sales price per cwt. Cost of goods sold of $181,600,000 increased $20,300,000 (13%) from 1996. Raw material costs increased $17,500,000 due to a 25% increase in bushels milled, from 22.4 million bushels in 1996 to 28.1 million bushels in 1997, partially offset by an average decrease of 74 cents per bushel for durum and wheat. Plant expenses increased $2,800,000 in 1997, primarily due to a full year of operations at the Kenosha mill compared to a half year in 1996. Marketing and administrative expenses were $6,700,000 in 1997, an increase of $2,200,000 (49%) from 1996. This increase reflects a full year of activity for the Kenosha mill while 1996 represented a half year as that mill began operations in November 1995, as well as some additional staffing and system expansion costs in anticipation of the future volumes from the Houston mill which began limited operation in June 1997. The Defined Business Unit incurred interest expense of $5,200,000 in 1997 compared to $4,500,000 in 1996. This increase of $700,000 (16%) is primarily related to the long-term debt used to finance the Kenosha mill. Comparison of Year Ended May 31, 1996 with 1995 The Defined Business Unit's net earnings of $2,900,000 for the year ended May 31, 1996 increased $2,100,000 over 1995. This increase in net earnings is attributable to higher volumes, largely the result of increased processing capacity generated by the opening of the Kenosha milling facility during the fiscal year 1996, and higher sales prices. Net sales of the Defined Business Unit of $173,300,000 increased by $53,600,000 (45%) from 1995, due to an increase in shipments of semolina and flour from 8,720,000 cwt to 10,720,000 cwt and an increase in the average price per cwt from $11.03 in 1995 to $12.64 in 1996. Cost of goods sold of $161,300,000 increased $48,600,000 (43%) from 1995. Raw material costs increased $46,000,000 due to an average increase of 83 cents per bushel for durum and wheat and a 38% increase in bushels sold of 6.7 million bushels, from 17.7 million bushels in 1995 to 24.4 million bushels in 1996. Plant expenses increased $2,600,000 in 1996, essentially all due to operations of the Kenosha mill, which did not begin milling until late 1995. Marketing and administrative expenses were $4,500,000 in 1996 an increase of $700,000 from 1995. This increase is attributable primarily to an increase of $900,000 due to staffing and system expansion to handle the additional volumes generated by the Kenosha mill, offset by a decrease of approximately $200,000 in pension expense related to a benefit plan settlement adjustment in 1995. The Defined Business Unit incurred interest expense of $4,500,000 in 1996 compared with $2,300,000 in 1995. This increase was attributable to increased short-term borrowings used to finance higher inventories and receivables primarily the result of production from the Kenosha mill and increased long-term debt used to finance construction of the Kenosha mill. Liquidity and Capital Resources The Defined Business Unit's cash needs are primarily the result of continued capital additions. The Defined Business Unit's Kenosha plant, which began operations in late 1995, represented an investment of $39,000,000. The Defined Business Unit's Houston plant, which began limited operations in June 1997, is expected to represent an investment of $17,700,000. In addition, the Harvest States Board of Directors has increased the authorized expenditures for the Pocono plant from $38,800,000 to $41,350,000. The Defined Business Unit expects capital additions to all its facilities. Commencement of operations at a particular facility involves increased working capital to fund required inventories and receivables related to increased sales. In addition, increased carrying value of inventories and receivables because of higher prices, increased receivables because of slow collections or increased inventories above historical levels requires additional financing. All of the Defined Business Unit's financing needs are expected to be met by the Company. Cash Flows from Operations Operating activities provided net cash of $19,600,000 in the year ended May 31, 1997, used net cash of $16,200,000 in 1996, and provided net cash of $7,800,000 in 1995, generally attributable to working capital needs, namely a decrease in working capital requirements in 1997 of $10,200,000, an increase in working capital requirements of $22,400,000 in 1996, and a decrease in working capital requirements of $4,500,000 in 1995. Cash requirements were offset by net earnings of $3,200,000, $2,900,000 and $800,000 in 1997, 1996 and 1995, respectively, and depreciation and amortization of $4,100,000, $3,300,000 and $2,500,000 in 1997, 1996 and 1995, respectively. For the year ended May 31, 1997 the reserve for obsolescence of the Rush City mill is also a noncash expense and therefore an offset to cash used. Cash Flows Used from Investing Net cash flows used in the Defined Business Unit's investing activities for the years ended 1997, 1996 and 1995 were $15,000,000, $18,600,000 and $30,700,000, respectively. Expenditures for the construction or acquisition of property, plant and equipment were $15,000,000, $18,100,000, and $25,100,000 for the years ended May 31, 1997,1996, and 1995, respectively. The Defined Business Unit also acquired intangibles of $500,000 and $5,600,000 in 1996 and 1995, respectively, related to the elimination of a minority interest effective June 1, 1994. Capital expenditures for fiscal year 1998 are expected to be $37,600,000, which includes $30,000,000 for the construction of the mill in Pocono, Pennsylvania. The total cost of construction of the Pocono mill is expected to be $41,350,000. The 1998 expected capital expenditures also include $4,100,000 for the completion of the construction of the Houston mill. The total cost of construction of the Houston mill is expected to be $17,700,000. Cash Flows from Financing Activities The Defined Business Unit's financing activities are coordinated through the Company's cash management department. Cash from all of the Company's operations is deposited with the Company's cash management department and disbursements are made centrally. As a result, the Defined Business Unit has a zero cash position. Financing is available from the Company to the extent of the Company's working capital position and corporate loan agreements with various banks and cash requirements of all other Company operations. Working capital requirements for each division and Defined Business Unit of the Company are reviewed on a periodic basis, and could potentially be restricted based upon management's evaluation of the prevailing business conditions and availability of funds. Short-term debt outstanding and payable to the Company as of May 31, 1997 and 1996 was $22,400,000 and $31,000,000, respectively. These interest bearing balances reflect working capital and fixed asset financing requirements of the respective years. On May 31, 1997 and 1996 the Defined Business Unit's long-term debt was $61,200,000 and $54,0000,000, respectively. This debt was incurred by the Defined Business Unit to retire debt assumed with the acquisition of the Huron facility in year ended May 31, 1990, to expand the Huron facility in the years ended May 31, 1990 and 1991, to construct the Kenosha facility in the years ended May 31, 1995 and 1996, and for the construction of the Houston facility in the years ended May 31, 1996 and 1997. ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA The financial statements listed in 14(a)(1) follow the signatures. Registrant is not required to provide the supplementary financial information required by Item 302. ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE Not applicable. PART III. ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT Board of Directors The table below lists the current directors of the Company, consisting of four members from District One (comprised of the states of Minnesota, Illinois, Iowa and Wisconsin), four members from District Two (comprised of the state of North Dakota), two members from District Three (comprised of the states of South Dakota, Kansas and Nebraska), two members from District Four (comprised of the states of Montana and Wyoming) and two members from District Five (comprised of the states of Washington, Oregon, Utah and Idaho). (In addition to the states referenced above, the Board of Directors has temporarily assigned the State of Missouri to District One, the States of Texas and Oklahoma to District Three, and the State of Colorado to District Four.) Each director must be an agricultural producer and an active patron of the Company (either directly or through an Affiliated Association) for a period of five years at the time of the director's election, must be less than 68 years of age at the time of election and cannot be an employee of the Company or of an Affiliated Association. The directors have been elected for staggered three-year terms, expiring in November of the years listed in the table below. Each director has been an agriculture producer for the past five years. Term Director Expires Name and Address Age District Since in Nov. - ---------------- --- -------- ----- ------- Steven Burnet 56 5 1983 1998 94699 Monkland Lane Moro, OR 97039-9705 Steve Carney 46 4 1988 1997 P.O. Box 1122 Scobey, MT 59263-1122 Edward Ellison 61 1 1978 1999 RR 1, Box 46 Elbow Lake, MN 56531-9740 Sheldon Haaland 58 1 1984 1997 RR 2, Box 55 Hanley Falls, MN 56245-9731 Jerry Hasnedl 50 1 1995 1998 RR 1, Box 39 St. Hilaire, MN 56754 Edward Hereford 58 5 1983 1997 RR 1, Box 53 Thornton, WA 99176-9710 Gerald Kuster 62 2 1979 1997 RR 1, Box 46 Reynolds, ND 58275-9742 Leonard Larsen 61 2 1993 1999 RR 1, Box 88 Granville, ND 58741 Tyrone Moos 59 3 1991 1997 HCR 1, Box 1 Phillip, SD 57567-9601 Duane Risan 61 2 1989 1998 RR 1, Box 4 Parshall, ND 58770-9703 Duane Stenzel 51 1 1993 1999 RR 2, Box 173 Wells, MN 56097 Russell Twedt 47 4 1993 1999 P.O. Box 296 Rudyard, MT 59540-0296 Merlin Van Walleghen 61 3 1993 1999 RR 1, Box 188 Letcher, SD 57359 William Zarak 62 2 1983 1998 3711 124th Ave. S.W. South Heart, ND 58655-9767 Approximately one-third of the directors are elected annually by members acting through delegates. STEVEN BURNET. Mr. Burnet has been a director since 1983 and currently serves as Chairman of the Board. He grows dryland wheat and barley and supports a cow/calf and yearling operation. Mr. Burnet is a member of the Oregon Wheat Growers League and the Oregon Cattlemen's Association. He also serves as a director on the Agricultural Co-op Council of Oregon. STEVE CARNEY. Mr. Carney has been a director since 1988 and currently serves as Secretary Treasurer. Mr. Carney operates a spring wheat and durum farm with his wife and brother. He is a former president of Farmers Union Grain Company (Peerless) and Farmers Union Grain Terminal of Daniels County. He is also a member of several local cooperatives. EDWARD ELLISON. Mr. Ellison has been a director since 1978. Together with his sons, he raises wheat, soybeans and corn on his Grant County, Minnesota, farm. Mr. Ellison is on the board of the Minnesota Association for Cooperatives and an alternate to the Agricultural Cooperative Development International (ACDI) board of directors. He also serves as a member of the Farmland Insurance and the Ag Utilization Research Institute (AURI) boards of directors. SHELDON HAALAND. Mr. Haaland has been a director since 1984 and currently serves as Assistant Secretary and Treasurer. He and his family farm 550 acres of corn, soybeans and wheat. Mr. Haaland is a member of several cooperatives and has previously served on the boards of Cottonwood Co-op Oil Company and Western Transport Co-op and as an advisory board member of the Southwest State University Co-op Program. JERRY HASNEDL. Mr. Hasnedl has been a director since 1995. He farms wheat, barley, sunflowers, corn, alfalfa and registered seed for MCIA. Mr. Hasnedl is a member of several cooperatives as well as the Minnesota Crop Improvement Association and Minnesota Farmers Union. He also is a farmer/dealer for Northrup King Seeds. EDWARD HEREFORD. Mr. Hereford has been a director since 1983. He and his two sons produce wheat, barley, peas and lentils on his dryland farm. Mr. Hereford is a director of the Idaho Co-op Council, a board member of the ACDI and a member of the Thornton Grange, the Washington Association of Wheat Growers and the Washington Association of Peas and Lentils Growers. GERALD KUSTER. Mr. Kuster has been a director since 1979. He and his sons operate a 3,000-acre farm. Mr. Kuster is President of Agri City Cooperative Services in Grand Forks, North Dakota, and Central Valley Bean Cooperative in Buxton, North Dakota. He also serves as president of Reynolds United Cooperative. LEONARD LARSEN. Mr. Larsen has been a director since 1993. He farms a 1,440-acre grain and sunflower operation and is vice president of the Granville area Development Corp. Mr. Larsen is also a member of Dakota Growers Pasta Company. TYRONE MOOS. Mr. Moos has been a director since 1991 and currently serves as Second Vice Chairman. He and his wife, together with their son and son-in-law, operate a combination farm and ranch raising winter wheat, barley and millet as well as managing cow-calf and hog finishing operations. Mr. Moos is a former member of the local co-op elevator board. DUANE RISAN. Mr. Risan has been a director since 1989. He raises durum, spring wheat and barley and, as a former educator, has a degree in mathematics and education from Jamestown College. He is a member of Dakota Growers Pasta Company and a patron of Dakota Quality Grain Co-op. DUANE STENZEL. Mr. Stenzel has been a director since 1993. He raises 620 acres of sweet corn, corn and soybeans on his south central Minnesota farm. Mr. Stenzel is a board member of Grainland Cooperative and past president of the Wells Farmer Elevator. RUSSELL TWEDT. Mr. Twedt has been a director since 1993. He is a third-generation Hill County farmer and rancher, and he and his family raise wheat and barley, with a cow/calf operation. He is a member of the Montana Grain Growers Association and Montana Farmers Union. MERLIN VAN WALLEGHEN. Mr. Van Walleghen has been a director since 1993. He and his son raise corn and soybeans and operate a livestock finishing operation. He is a past Board president of the Mitchell Farmers Cooperative Elevator Association and past member of Mitchell Technical Institutes Agricultural Advisory Board. He is also Chairman of the Sanborn County Development Board. WILLIAM ZARAK. Mr. Zarak has been a director since 1983 and currently serves as First Vice Chairman. He owns and operates a 2,000-acre farm with his wife and two sons where they raise small grains, corn, beef cows and hogs and also backgrounds calves. Mr. Zarak is also a member of Dakota Growers Pasta Company. Directors' Compensation The Board of Directors meets monthly. The Company provides its directors with annual compensation of $24,000, paid in twelve monthly payments, with the Chairman of the Board receiving an additional annual compensation of $6,000, paid in twelve monthly payments, a per diem payment of $122.50 plus travel allowance for actual days away from home while attending Board Meetings, a per diem of $250 plus actual expenses and travel allowance for each day spent on other Company business, life insurance, and an annuity plan providing for benefits to become payable monthly when a director reaches age 62. Committees of the Board of Directors The Board of Directors does not have any standing committees. The Board appoints ad hoc committees from time to time to review certain matters and make reports and recommendations to the full Board of Directors for action. The entire Board of Directors determines the salary and incentive compensation of the Chief Executive Officer and reviews the results and scope of the audit and other services provided by the Company's independent auditors, as well as the Company's accounting principles and its system of internal controls. Compensation Committee Interlocks and Insider Participation As noted above, the Company's Board of Directors does not have a Compensation Committee. The entire Board of Directors determines the compensation of the Chief Executive Officer and the terms of the employment agreement with the Chief Executive Officer. The Chief Executive Officer determines the compensation for all other executive officers. Limitation of Liability and Indemnification The Company's Articles of Incorporation limit the liability of directors in their capacity as directors to the full extent permitted by Minnesota law. As permitted by Minnesota law, the Company's Articles of Incorporation provide that a director shall not be personally liable to the Company or its members for monetary damages for breach of fiduciary duty as a director, except for liability for a breach of the director's duty of loyalty to the Company or its members, for acts of omissions not in good faith or that involve intentional misconduct or a knowing violation of law, for a transaction from which the director derived an improper personal benefit or for an act or omission occurring prior to the date when such provisions became effective. The provision of the Articles of Incorporation limits only the liability of directors, not officers. These provisions do not affect the availability of equitable remedies, such as an action to enjoin or rescind a transaction involving a breach of fiduciary duty, although, as a practical matter, equitable relief may not be available. The above provisions also do not limit liability of the directors for violations of, or relieve them from the necessity of complying with, the federal securities laws. The Bylaws of the Company require the Company to indemnify each director, officer, manager, employee or agent of the Company, and any person serving at the request of the Company as a director, officer, manager, employee or agent of another corporation, partnership, joint venture, trust or other enterprise, against expenses, including attorneys' fees, judgments, fines and amounts paid in settlement actually and reasonably incurred to the fullest extent permitted under the laws of Minnesota. Executive Officers The table below lists the executive officers of the Company, none of whom holds any equity in the Company. Officers are elected annually by the Board of Directors.
Name Age Position ---- --- -------- John D. Johnson 48 President and Chief Executive Officer T. F. Baker 54 Group Vice President - Finance Michael H. Bergeland 52 Group Vice President - Grain & Agri Services Garry A. Pistoria 55 Group Vice President - Wheat Milling James Tibbetts 47 Group Vice President - Oilseed Processing and Packaging
JOHN D. JOHNSON. Mr. Johnson was appointed President and Chief Executive Officer on January 1, 1995. Prior to his appointment to that position he held positions as Group Vice President of Farm Marketing & Supply, GTA Feeds Division General Manager, Director of Sales and Marketing for the GTA Feeds Division, Regional Sales Manager for GTA Feeds Division, and Feed Consultant GTA Feeds Division. He has 20 years total experience with the Company. Mr. Johnson graduated in 1970 from Black Hills State University at Spearfish, South Dakota, with a degree in Business Administration and Economics. He also serves on the Board of Directors of the National Council of Farmer Cooperatives (NCFC) and A. C. Toepfer Intrade Grain Companies, and is Chairman of the NCFC Agriculture, Trade & Credit Committee. Mr. Johnson also serves on the Management Committee for Ventura Foods, LLC. THOMAS F. BAKER. Mr. Baker joined the Company in 1982 as Vice President of Finance. In 1992 he was appointed Group Vice President of Finance and holds that position at the present time. Mr. Baker obtained a Bachelor's Degree in accounting from the College of St. Thomas, did graduate work at the University of Minnesota, and obtained his CPA in the State of Minnesota. Mr. Baker serves on the Board of Governors for Ag States Agency, LLC and on the Management Committee for Ventura Foods, LLC. He is also a member of Minnesota Certified Public Accountants and Financial Executives Institute. MICHAEL H. BERGELAND. Mr. Bergeland, Group Vice President of Grain and Agri-Services, joined the Company in 1967. He is a native of Minnesota and attended Moorhead State College. Mr. Bergeland also serves as a board member of the Minneapolis Grain Exchange, Chairman of the Grain Committee for the National Council of Farmer Cooperatives, and a Committee Member and alternate director for A.C. Toepfer Intrade Grain. GARRY A. PISTORIA. Mr. Pistoria has been Group Vice President of Wheat Milling since 1985 and has been with the Company since 1961. Mr. Pistoria attended Montana State University and the College of Great Falls. He is a member of the National Pasta Association, the American Bakers Association and the Minneapolis Grain Exchange. JAMES TIBBETTS. On January 1, 1997, Mr. Tibbetts was appointed to the position of Group Vice President of the Oilseed Processing and Refining Division. From November of 1995 (when he joined the Company) through 1996, Mr. Tibbetts was Senior Vice President for the former Consumer Products Packaging Division (Holsum Foods Division). From 1977 to 1995, Mr. Tibbetts was a Senior Vice President for Farm Credit Leasing in Minneapolis, Minnesota. Mr. Tibbetts received a Bachelor of Science Degree in Business Administration in 1972 from Northern State University in Aberdeen, South Dakota. He serves on the Management Committee for Ventura Foods, LLC. ITEM 11. EXECUTIVE COMPENSATION Summary Compensation. The following table sets forth the cash and noncash compensation earned by the Chief Executive Officer and each of the four most highly compensated executive officers of the Company (other than the Chief Executive Officer) whose total salary and bonus or similar incentive payment earned during the year ended May 31, 1997, exceeded $100,000 (the "Named Executive Officers"): Summary Compensation Table
Annual Compensation ------------------------------------------------------------- Year Ended Other Annual All Other May 31, Salary(1) Bonus(1) Compensation(2) Compensation(3) ------- --------- -------- --------------- --------------- John D. Johnson President and Chief Executive Officer .. 1997 $500,000 150,000 $ 7,172 $ 7,186 Thomas F. Baker Group Vice President-- Finance ............ 1997 235,000 122,200 9,226 6,036 Michael H. Bergeland Group Vice President-- Grain and Agri- Services ........... 1997 224,000 120,000 7,048 7,890 Garry A. Pistoria Group Vice President-- Wheat Milling ...... 1997 180,000 90,000 6,905 5,474 James Tibbetts Group Vice President-- Oilseed Processing and Refining Division ........... 1997 160,000 80,000 5,699 2,882
- -------------------- (1) Amounts shown include amounts deferred at the employee's election under the Company's Deferred Compensation Program. (2) Amounts shown include personal use of a Company vehicle. (3) Other compensation includes the Company's matching contributions under the Company's 401(K) Plan and the portion of group term life insurance premiums paid by the Company. On January 23, 1997, the Company entered into an Employment Agreement with John D. Johnson. The Employment Agreement provides for a rolling three-year period of employment commencing on January 23, 1997, at an initial base or fixed salary of at least $500,000, subject to annual review. Mr. Johnson's employment may be terminated by either party on at least 30 days' written notice, subject to the rights and obligations set forth in the Employment Agreement. The Company is obligated to pay Mr. Johnson a severance allowance for three years equal to Mr. Johnson's base or fixed salary and to continue family health insurance coverage for at least one year in the event Mr. Johnson's employment is terminated for any reason other than for cause (as such term is defined in the Employment Agreement), death, disability or voluntary termination. The Employment Agreement also contains covenants by Mr. Johnson not to compete with the Company and not to solicit the Company's customers or employees during the period that Mr. Johnson accepts the severance allowance. The Company and Mr. Johnson have also agreed that in the event of Mr. Johnson's voluntary termination the Company will not owe Mr. Johnson any severance allowance and Mr. Johnson will not compete against the Company for a period of three years. Either party may terminate the Employment Agreement and all of the rights and obligations of the parties thereunder, upon at least three years' written notice to the other party. Management Compensation Incentive Program Each Named Executive Officer is eligible to participate in the Management Compensation Incentive Program (the "Incentive Program") for the year ending May 31, 1997. The Incentive Program is based on Company and group or division performance. The criteria for measurement consists of Economic Value Added (EVA), earnings and Member Value Index; a subjective evaluation of value provided to members and customers. These amounts were paid after May 31, 1997. The maximum incentive is 60% of base compensation. Retirement Plan Each of the Named Executive Officers is entitled to receive benefits under the Harvest States Cooperatives Cash Balance Retirement Plan (the "Retirement Plan"). An employee's benefit under the Retirement Plan depends on credits to the employee's account, which are based on the employee's total salary each year the employee works for the Company, the length of service with the Company and the rate of interest credited to the employee's account balance each year. Credits are made to the employee's account from Pay Credits, Special Career Credits and Investment Credits. The amount of Pay Credits added to an employee's account each year is a percentage of the employee's gross salary, including overtime pay, commissions, severance pay, bonuses, any compensation reduction pursuant to the 401(K) Plan and any pretax contribution to any of the Company's welfare benefit plans, paid vacations, paid leaves of absence and pay received if away from work due to a sickness or injury. The Pay Credits percentage received is determined on a yearly basis, based on the years of Benefit Service completed as of January 1 of each year. An employee receives one year of Benefit Service for every calendar year of employment in which the employee completed at least 1,000 hours of service. Effective January 1, 1997, Pay Credits are earned according to the following schedule: Years of Benefit Service: Pay Credit Equals: ------------------------- ------------------ 1 to 7 years 4% of total salary 8 to 11 years 5% of total salary 12 years and more 6% of total salary Special Career Credits were designed to supplement the benefits of mid-career employees affected by the change from the former plan to the current Retirement Plan. Employees qualify for Special Career Credits only if they were employed by the Company and met certain age and service requirements (as defined by the Retirement Plan) on January 1, 1988. The following table shows the credits for those who qualify: Total of Age and Benefit Service on January 1, 1988: Special Career Credits: --------------------------- ----------------------- 50 to 54 1% of total salary 55 to 59 2% of total salary 60 to 64 3% of total salary 65 to 69 4% of total salary 70 or more 5% of total salary Special Career Credits continue at the percentage rate determined from the employee's status on January 1, 1988, for as long as the employee is with the Company. The Company credits an employee's account at the end of the year with an Investment Credit based on the balance at the beginning of the year. The Investment Credit is based on the average return for one-year U.S. Treasury Bills for the preceding 12-month period. The maximum Investment Credit will not exceed 12% for any year. As of December 31, 1996, the dollar value of the account of each of the Named Executive Officers was: John D. Johnson .................. $180,334 Thomas F. Baker .................. 215,878 Michael H. Bergeland ............. 379,744 Garry A. Pistoria ................ 441,761 James Tibbetts ................... 2,258 Mr. Pistoria and Mr. Bergeland could be eligible for a retirement benefit, under a grandfather provision of a prior provision of the plan, instead of the above amount. Such amount would be affected by age at retirement and salary. Deferred Compensation Plan Effective April 1, 1994, the Company established the Harvest States Cooperatives Deferred Compensation Plan (the "Deferred Compensation Plan"). Participants in the Deferred Compensation Plan are select management or highly compensated employees of the Company who have been designated as eligible by the President of the Company to participate in such plan. Under the Deferred Compensation Plan, a participant may elect to have an amount of deferred compensation credited to the participant's account for the applicable Plan Year (as defined in the Deferred Compensation Plan). The compensation actually earned during the Plan Year by a participant who elects deferred compensation is reduced by the percentage or amount so elected. A participant may elect to contribute no more than 30% of each payment of base compensation, provided that the percentage selected is expected to result in annual contributions totaling at least $1,000. Also, the participant may elect to contribute either a percentage or a specific dollar amount of any bonus or similar incentive payment that may become payable during the Plan Year, provided the contribution will not be less than the smaller of $1,000 or 100% of the bonus payable. The deferred compensation credited under the Deferred Compensation Plan is allocated to the account of the participant as of the date that the compensation would otherwise have been paid to the Participant in cash. Income is credited to each account each Plan Year at an annual rate equal to 1% over the five-year U.S. Treasury Bond rate as of October 1 of the year preceding the Plan Year, as adjusted as appropriate to reflect contributions to and distributions from the account during the Plan Year. A participant's credits to his or her account are unsecured obligations of the Company to pay the participant the actual amount of the credits upon distribution pursuant to the Deferred Compensation Plan. Each participant or beneficiary is only a general creditor of the Company with respect to his or her account. Accounts are maintained for recordkeeping purposes only. Obligations of the Company to pay benefits under the Deferred Compensation Plan may be satisfied by distributions from a grantor trust created by the Company in its sole discretion for such purpose. The Company has not created any such trust. Amounts credited to a participant's account are distributed on a predetermined date, such as the date of retirement or the date the participant attains a particular age, in either a lump sum or in installments pursuant to the participant's prior irrevocable election. The Deferred Compensation Plan also provides for distribution upon the participant's death or disability, for unforeseeable emergencies and upon termination of the plan. The President of the Company may at any time amend the Plan in whole or in part for any reason. No amendment may decrease the benefits under the Plan which have accrued prior to the date of such amendment, but any amendment may modify the interest rate to be used for future deferrals and for the balance in each account on the date the amendment was adopted. The Company, by action of the President, may at any time terminate the Plan. 401(k) Plan Each Named Executive Officer is eligible to participate in the Harvest States Cooperatives Savings Plan (the "401(k) Plan"). All employees of the Company who are eligible for the Retirement Plan and who are not production employees and who are not covered by a collective bargaining agreement are eligible to participate in the 401(k) Plan. Effective January 1, 1997 participants may contribute between 1% and 15% (not to exceed 8% in the case of "highly compensated" employees) of their pay on a pre-tax basis. Each of the Named Executive Officers is a "highly compensated" employee. The Company matches 50% of the first 6% of pay contributed each year. The Company's Board of Directors may elect to reduce or eliminate matching contributions for any year or any portion thereof. Participants are 100% vested in their own contributions and in any Company matching contribution made on the participant's behalf. Deferred Compensation Supplemental Retirement Plan Each of the Named Executive Officers may participate in the Harvest Sates Cooperatives Deferred Compensation Supplemental Retirement Plan (the "Supplemental Plan"). Participants in the Supplemental Plan are select management or highly compensated employees of the Company who have been designated as eligible by the President of the Company to participate in such plan. Compensation deferred under the Deferred Compensation Plan is not eligible for Pay Credits or Special Career Credits under the Cash Balance Retirement Plan or matching contributions under the 401(k) Plan. The Supplemental Plan is intended to replace the benefits lost under those plans due to Section 415 of the Internal Revenue Code of 1986, as amended (the "Code") which cannot be considered for purposes of benefits due to Section 401(a)(17) of the Code under the qualified plans that the Company offers. The Supplemental Plan is not funded or qualified for special tax treatment under the Code. As of December 31, 1996, the dollar value of the account of each of the Named Executive Officers will be approximately: John D. Johnson ...................... $94,772 Thomas F. Baker ...................... 62,161 Michael H. Bergeland ................. 526,035 Garry A. Pistoria .................... 723,252 James Tibbetts ....................... -- ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT Beneficial ownership of equity securities as of July 31, 1997, is shown below:
Amount and nature of Title of beneficial Class Name of beneficial owner (1) ownership % of Class - ----- ---------------------------- --------- ---------- Wheat Milling Equity Participation Units: Directors: Steven Burnet 30,000 units * Steve Carney 27,000 units * Edward Ellison 6,000 units * Sheldon Haaland -- Jerry Hasnedl 10,000 units * Edward Hereford -- Gerald Kuster 22,000 units * Leonard Larsen 9,000 units * Tyrone Moos 3,000 units * Duane Risan 24,000 units * Duane Stenzel -- Russell Twedt 5,000 units * Merlin Van Walleghen -- William Zarak 6,000 units * John D. Johnson -- Thomas F. Baker -- Michael H. Bergeland -- Garry A. Pistoria -- James Tibbetts -- ---------------- ----- Directors and executive officers as a group 142,000 units 2.97% ---------------- ----- Oilseed Processing and Refining Equity Participation Units: Directors: Steven Burnet -- Steve Carney -- Edward Ellison 12,000 units 1.12% Sheldon Haaland 1,500 units * Jerry Hasnedl 1,500 units * Edward Hereford -- Gerald Kuster 5,000 units * Leonard Larsen -- Tyrone Moos -- Duane Risan -- Duane Stenzel 2,500 units * Russell Twedt -- Merlin Van Walleghen 6,000 units * William Zarak -- John D. Johnson -- Thomas F. Baker -- Michael H. Bergeland -- Garry A. Pistoria -- James Tibbetts -- ---------------- ----- Directors and executive officers as a group 28,500 units 2.65% ---------------- -----
- ---------------------------------- (1) Includes units held by spouse. * Less than 1%. No director listed above has the right or option to acquire beneficial ownership in additional securities other than by purchase on the open market from current holders of such securities. Executive officers, as non-producers, are ineligible to hold these securities. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS Because directors must be active patrons of the Company or an Affiliated Association, transactions between the Company and directors are customary and expected. Transactions include the sale of commodities to the Company and the purchase of products and services from the Company. During each of the three years ended May 31, 1997, the value of those transactions between a particular director (and members of such directors' immediate family, which includes such director's spouse; parents; children; siblings; mothers and fathers-in-law; sons and daughters-in-law; and brothers and sisters-in-law) and the Company that exceeded $60,000 are shown below. Year Ended May 31, ---------------------------------------- Name 1997 1996 1995 - ------------- -------- -------- -------- William Zarak $ 55,644 $303,125 $ 72,863 Russell Twedt 101,031 121,257 94,704 Steve Carney 250,641 746,263 466,933 Tyrone Moos 172,527 Jerry Hasnedl 143,369 Merlin Van Walleghen 148,275 PART IV. ITEM 14. EXHIBITS, FINANCIAL STATEMENTS AND REPORTS FILED ON FORM 8-K (a) (1) FINANCIAL STATEMENTS The following financial statements and the Report of Independent Accountants therein are filed as part of this Form 10-K. I. HARVEST STATES COOPERATIVES Report of Independent Accountants Consolidated Balance Sheets as of May 31, 1997 and 1996 Consolidated Statements of Earnings for the Years Ended May 31, 1997, 1996, and 1995 Consolidated Statements of Capital for the Years Ended May 31, 1997, 1996, and 1995 Consolidated Statements of Cash Flows for the Years Ended May 31, 1997, 1996, and 1995 Notes to Consolidated Financial Statements for the Years Ended May 31, 1997, 1996, and 1995 II. OILSEED PROCESSING AND REFINING DEFINED BUSINESS UNIT Report of Independent Accountants Balance Sheets as of May 31, 1997 and 1996 Statements of Earnings for the Years Ended May 31, 1997, 1996, and 1995 Statements of Defined Business Unit Equity for the Years Ended May 31, 1997, 1996, and 1995 Statements of Cash Flows for the Years Ended May 31, 1997, 1996, and 1995 Notes to Financial Statements for the Years Ended May 31, 1997, 1996, and 1995 III. WHEAT MILLING DEFINED BUSINESS UNIT Report of Independent Accountants Balance Sheets as of May 31, 1997 and 1996 Statements of Earnings for the Years Ended May 31, 1997, 1996, and 1995 Statements of Defined Business Unit Equity for the Years Ended May 31, 1997, 1996, and 1995 Statements of Cash Flows for the Years Ended May 31, 1997, 1996, and 1995 Notes to Financial Statements for the Years Ended May 31, 1997, 1996, and 1995 (a) (2) FINANCIAL STATEMENT SCHEDULES None. (a) (3) EXHIBITS 3.1 Amended and Restated Articles of Incorporation of the Company. (1) 3.2 Amended and Restated Bylaws of the Company. (1) 4.1 Resolutions of the Board of Directors creating the Equity Participation Units (Processing and Refining). (1) 4.2 Resolutions of the Board of Directors creating the Participation Units (Milling). (1) 10.1+ Lease Agreement between Peavey Company and Amber Milling Company, a division of Harvest States Cooperatives, effective as of August 31, 1994. (1) 10.2 Lease between the Port of Kalama and North Pacific Grain Growers, Inc., dated November 22, 1960. (1) 10.3 Limited Liability Company Agreement for the Wilsey-Holsum Foods, LLC dated July 24, 1996. (1) 10.4+ Long Term Supply Agreement between Wilsey-Holsum Foods, LLC and Harvest States Cooperatives dated August 30, 1996. (1) 10.5 Partnership Agreement between Continental Grain Company and Harvest States Cooperatives dated September 23, 1992. (1) 10.5(a) Amendment No. 1 to Partnership Agreement between Continental Grain and Harvest States Cooperatives effective June 1, 1997. (2) 10.6 Harvest States Cooperatives Deferred Compensation Plan. (1) 10.7 Harvest States Cooperatives Deferred Compensation Supplemental Retirement Plan. (1) 10.8 Harvest States Cooperatives Management Compensation Program. (1) 10.9 Revolving Credit Agreement by and among Harvest States Cooperatives, Banque Nationale de Paris et al., the St. Paul Bank for Cooperatives and CoBank, ACB dated November 1, 1996. (1) 10.10 Amended and Restated Master Syndicated Loan Agreement by and among Harvest States Cooperatives, CoBank, ACB (successor to the National Bank for Cooperatives) and the St. Paul Bank for Cooperatives dated October 28, 1996. (1) 10.11 Fourth Supplement to the August 30, 1994 Master Syndicated Loan Agreement by and among Harvest States Cooperatives, CoBank, ACB (successor to the National Bank for Cooperatives) and the St. Paul Bank for Cooperatives dated October 28, 1996. (1) 10.11(a) Promissory Note of Harvest States Cooperatives to the St. Paul Bank for Cooperatives for $25,000,000 dated October 28, 1996. (1) 10.11(b) Promissory Note of Harvest States Cooperatives to CoBank, ACB for $25,000,000 dated October 28, 1996. (1) 10.12 Third Supplement to the August 30, 1994 Master Syndicated Loan Agreement by and among Harvest States Cooperatives, CoBank, ACB (successor to the National Bank for Cooperatives) and the St. Paul Bank for Cooperatives dated December 15, 1995. (1) 10.12(a) Promissory Note of Harvest States Cooperatives to the St. Paul Bank for Cooperatives for $10,000,000 dated December 15, 1995. (1) 10.12(b) Promissory Note of Harvest States Cooperatives to CoBank, ACB for $10,000,000 dated December 15, 1995. (1) 10.13 First Supplement to the August 30, 1994 Master Syndicated Loan Agreement by and among Harvest States Cooperatives, the National Bank for Cooperatives and the St. Paul Bank for Cooperatives dated August 30, 1994. (1) 10.13(a) Promissory Note of Harvest States Cooperatives to the St. Paul Bank for Cooperatives for $42,500,000 dated August 30, 1994. (1) 10.13(b) Promissory Note of Harvest States Cooperatives to the National Bank for Cooperatives for $42,500,000 dated August 30, 1994. (1) 10.14 Employment Agreement between John D. Johnson and Harvest States Cooperatives dated January 23, 1997. (1) 10.15 Lease Agreement between the Port of Houston Authority of Harris County, Texas and Harvest States Cooperatives, dated October 3, 1995. (1) 10.16 Lease Agreement between Lackawanna County Railroad Authority and Amber Milling Company, a division of Harvest States Cooperatives dated June 1, 1997. (2) 21.1 Subsidiaries of the Registrant. (1) 24 Power of Attorney. (2) 27 Financial Data Schedule. (2) - -------------------------------- + Pursuant to Rule 406 of the Securities Act of 1933, as amended, confidential portions of Exhibits 10.1 and 10.4 have been deleted and filed separately with the Securities and Exchange Commission pursuant to a request for confidential treatment. (1) Incorporated by reference to the Company's Registration Statement on Form S-1 (File No. 333-17865), effective February 14, 1997. (2) Filed herewith. (b) REPORTS ON FORM 8-K No reports on Form 8-K have been filed by the Registrant during the fourth quarter of the year ended May 31, 1997. (c) EXHIBITS The exhibits shown in Item 14(a)(3) above are being filed herewith. (d) SCHEDULES None. SUPPLEMENTAL INFORMATION The Company has not yet distributed annual reports. It will do so in November of 1997 and will provide a copy to the Commission at that time. As a cooperative, the Company does not utilize proxy statements. SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, as amended, the Registrant has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized, on August 26, 1997. HARVEST STATES COOPERATIVES By: /s/ John D. Johnson - ------------------------- John D. Johnson President and Chief Executive Officer Pursuant to the requirements of the Securities Exchange Act of 1934, this Report has been signed below by the following persons on behalf of the Registrant and in the capacities indicated on August 26, 1997: /s/ John D. Johnson President and Chief Executive Officer - -------------------------- (principal executive officer) John D. Johnson /s/ T. F. Baker Group Vice President - Finance - -------------------------- (principal financial officer) T. F. Baker /s/ John Schmitz Vice President - Corporate Accounting - -------------------------- (principal accounting officer) John Schmitz Steven Burnet* Chairman of the Board of Directors Steve Carney* Director Sheldon Haaland* Director Jerry C. Hasnedl* Director Edward Hereford* Director Gerald Kuster* Director Tyrone A. Moos* Director Duane G. Risan* Director William J. Zarak, Jr.* Director Edward Ellison* Director Leonard D. Larsen* Director Duane Stenzel* Director Russell W. Twedt* Director Merlin Van Walleghen* Director * By /s/ John D. Johnson --------------------------- John D. Johnson Attorney - in - fact INDEPENDENT AUDITORS' REPORT Board of Directors Harvest States Cooperatives Saint Paul, Minnesota We have audited the consolidated balance sheets of Harvest States Cooperatives and subsidiaries (the Company) as of May 31, 1997 and 1996 and the related consolidated statements of earnings, capital, and cash flows for each of the three years in the period ended May 31, 1997. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall consolidated financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of the Company at May 31, 1997 and 1996 and the results of its operations and its cash flows for each of the three years in the period ended May 31, 1997, in conformity with generally accepted accounting principles. Deloitte & Touche, LLP August 15,1997 HARVEST STATES COOPERATIVES AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS MAY 31, 1997 AND 1996 - -------------------------------------------------------------------------------- 1997 1996 ASSETS CURRENT ASSETS: Cash $ 38,064,191 $ 21,426,227 Receivables (Note 2) 267,517,690 367,244,539 Inventories (Note 3) 248,373,247 434,507,118 Prepaid expenses and deposits 25,562,366 41,825,850 --------------- -------------- Total current assets 579,517,494 865,003,734 OTHER ASSETS: Investments (Note 4) 126,547,616 83,269,566 Other (Note 5) 46,489,678 48,353,983 --------------- -------------- Total other assets 173,037,294 131,623,549 PROPERTY, PLANT, AND EQUIPMENT (Notes 6 and 7) 224,150,965 232,145,401 --------------- -------------- $ 976,705,753 $1,228,772,684 =============== ============== LIABILITIES AND CAPITAL CURRENT LIABILITIES: Notes payable (Note 7) $ 98,000,000 $ 324,000,000 Patron credit balances 25,190,513 29,007,419 Advances received on grain sales 125,071,207 201,825,190 Drafts outstanding 32,698,943 23,837,715 Accounts payable and accrued expenses 152,451,010 163,435,268 Patronage dividends payable 13,200,000 13,100,000 Current portion of long-term debt (Note 7) 21,094,774 13,923,204 --------------- -------------- Total current liabilities 467,706,447 769,128,796 LONG-TERM DEBT (Note 7) 113,363,692 118,705,972 OTHER LIABILITIES 10,536,301 3,685,797 COMMITMENTS AND CONTINGENCIES (Notes 8 and 13) CAPITAL (Note 8) 385,099,313 337,252,119 --------------- -------------- $ 976,705,753 $1,228,772,684 =============== ============== See notes to consolidated financial statements. HARVEST STATES COOPERATIVES AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF EARNINGS YEARS ENDED MAY 31, 1997, 1996, AND 1995 - -------------------------------------------------------------------------------- 1997 1996 1995 REVENUES: Sales: Grain $ 6,036,502,624 $ 7,127,223,407 $ 4,191,665,535 Processed grain 730,101,124 819,863,541 708,219,307 Feed and farm supplies 258,235,512 207,252,696 156,699,068 ----------------- ----------------- ----------------- 7,024,839,260 8,154,339,644 5,056,583,910 Patronage dividends 15,947,049 13,278,997 6,512,481 Other revenues (Note 12) 68,627,552 68,339,523 57,556,984 ----------------- ----------------- ----------------- 7,109,413,861 8,235,958,164 5,120,653,375 COSTS AND EXPENSES: Cost of goods sold 6,967,937,476 8,076,073,326 4,981,820,272 Marketing, general, and administrative 63,341,552 70,054,248 69,509,491 Interest 19,378,833 31,921,936 19,268,575 ----------------- ----------------- ----------------- 7,050,657,861 8,178,049,510 5,070,598,338 ----------------- ----------------- ----------------- EARNINGS BEFORE INCOME TAXES 58,756,000 57,908,654 50,055,037 INCOME TAXES (Note 11) 6,200,000 6,900,000 5,100,000 ----------------- ----------------- ----------------- NET EARNINGS $ 52,556,000 $ 51,008,654 $ 44,955,037 ================= ================= ================= DISTRIBUTION OF NET EARNINGS: Cash to patrons $ 13,200,000 $ 13,220,462 $ 10,992,918 Patronage certificates 30,800,000 30,877,406 25,617,898 Nonpatronage certificates 7,885,168 6,115,487 7,912,297 Capital reserve 670,832 795,299 431,924 ----------------- ----------------- ----------------- Net earnings $ 52,556,000 $ 51,008,654 $ 44,955,037 ================= ================= =================
See notes to consolidated financial statements. HARVEST STATES COOPERATIVES AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CAPITAL - -------------------------------------------------------------------------------- OILSEED WHEAT PROCESSING & PATRONAGE NONPATRONAGE MILLING REFINING PATRONAGE CAPITAL TOTAL CERTIFICATES CERTIFICATES EPU'S EPU'S PAYABLE RESERVE ------------ ------------ ------------ ----------- ----------- ------------ ----------- BALANCE AT MAY 31, 1994: Stated as capital $270,761,017 $198,157,446 $ 21,900,000 $50,703,571 Stated as current liability 9,400,000 9,400,000 ------------ ------------ ------------ 280,161,017 198,157,446 31,300,000 50,703,571 Distribution of patronage dividends payable for preceding year, including cash payment of $9,945,967 (9,945,967) 23,187,069 $ 1,832,136 (31,300,000) (3,665,172) Redemption of capital equity certificates (5,728,997) (5,728,997) Other 1,046,803 150,004 896,799 Net earnings 44,955,037 36,700,000 8,255,037 Patronage dividends payable in cash, stated as a current liability (11,000,000) (11,000,000) ------------ ------------ ----------- ------------ BALANCE AT MAY 31, 1995: Stated as capital 299,487,893 215,765,522 1,832,136 25,700,000 56,190,235 Stated as current liability 11,000,000 11,000,000 ------------ ------------ ----------- ------------ 310,487,893 215,765,522 1,832,136 36,700,000 56,190,235 Distribution of patronage dividends payable for preceding year, including cash payment of $10,992,918 (10,992,918) 25,617,898 7,912,297 (36,700,000) (7,823,113) Redemption of capital equity certificates (6,554,160) (6,547,372) (6,788) Equities issued 8,721,542 8,721,542 Other (2,318,892) (2,041,438) 2,350 (279,804) Net earnings 51,008,654 43,700,000 7,308,654 Patronage dividends payable in cash, stated as a current liability (13,100,000) (13,100,000) ------------ ------------ ----------- ------------ BALANCE AT MAY 31, 1996: Stated as capital 337,252,119 241,516,152 9,739,995 30,600,000 55,395,972 Stated as current liability 13,100,000 13,100,000 ------------ ------------ ----------- ------------ 350,352,119 241,516,152 9,739,995 43,700,000 55,395,972 Distribution of patronage dividends payable for preceding year, including cash payment of $13,220,462 (13,220,462) 30,877,406 6,115,487 (43,700,000) (6,513,355) Redemption of capital equity certificates (8,204,091) (8,130,378) (73,713) Equities issued 5,066,250 5,066,250 Other 912,807 89,752 (637,329) 1,460,384 Net earnings 52,556,000 44,000,000 8,556,000 Initial investment offering 10,836,690 (2,035,171) $ 9,574,000 $ 4,296,000 (998,139) Patronage dividends payable in cash, stated as a current liability (13,200,000) (13,200,000) ------------ ------------ ----------- ----------- ----------- ------------ ----------- BALANCE AT MAY 31, 1997 $385,099,313 $267,384,011 $15,144,440 $ 9,574,000 $ 4,296,000 $ 30,800,000 $57,900,862 ============ ============ =========== =========== =========== ============ ===========
See notes to consolidated financial statements. HARVEST STATES COOPERATIVES AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS YEARS ENDED MAY 31, 1997, 1996, AND 1995 - -------------------------------------------------------------------------------- 1997 1996 1995 CASH FLOWS FROM OPERATING ACTIVITIES: Net earnings $ 52,556,000 $ 51,008,654 $ 44,955,037 Adjustments to reconcile net earnings to net cash flows: Depreciation and amortization 20,450,050 20,421,425 18,907,903 Noncash gain on investment (11,598,013) (12,517,993) (4,025,854) Noncash portion of patronage dividends received (11,050,057) (9,607,657) (4,622,221) Loss (gain) on sale of property, plant, and equipment 4,612,341 (853,024) (1,196,717) Change in assets and liabilities: Receivables 99,499,286 (33,013,948) (103,580,123) Inventories 186,133,871 (186,968,498) (19,046,875) Patron credit balances (3,816,906) (30,483,224) 23,282,391 Advances received on grain sales (76,753,983) 78,403,202 (1,264,842) Accounts payable, accrued expenses, and drafts outstanding (2,123,030) 43,477,378 4,852,493 Prepaid expenses, deposits, and other 13,693,059 (25,590,317) (7,973,268) ------------- ------------- -------------- Total adjustments 219,046,618 (156,732,656) (94,667,113) ------------- ------------- -------------- Net cash provided by (used in) operating activities 271,602,618 (105,724,002) (49,712,076) CASH FLOWS FROM INVESTING ACTIVITIES: Proceeds from disposition of property, plant, and equipment 1,763,543 3,729,810 3,351,119 Investments redeemed 14,863,786 2,518,863 3,662,026 Acquisition of property, plant, and equipment (42,372,618) (40,501,980) (69,314,689) Payments on notes receivable 632,526 398,851 391,412 Investments (1,274,069) (1,843,097) Investments in joint ventures 5,736,097 (727,266) (6,650,000) Other (437,941) (1,778,678) (1,004,755) ------------- ------------- --------------- Net cash used in investing activities (19,814,607) (37,634,469) (71,407,984) CASH FLOWS FROM FINANCING ACTIVITIES: Net (payments) borrowings under line of credit agreements (226,000,000) 124,000,000 87,000,000 Long-term debt borrowings 18,795,000 57,961,058 51,000,000 Principal payments on long-term debt (16,094,879) (10,546,075) (5,215,106) Principal payments under capital lease obligations (1,262,305) (739,884) (680,901) Redemption of capital equity certificates (8,204,091) (6,554,160) (5,728,997) Proceeds from sale of equity participation units, net of expenses 10,836,690 Cash patronage dividends paid (13,220,462) (10,992,918) (9,945,967) ------------- ------------- -------------- Net cash (used in) provided by financing activities (235,150,047) 153,128,021 116,429,029 ------------- ------------- -------------- INCREASE (DECREASE) IN CASH 16,637,964 9,769,550 (4,691,031) CASH AT BEGINNING OF YEAR 21,426,227 11,656,677 16,347,708 ------------- ------------- -------------- CASH AT END OF YEAR $ 38,064,191 $ 21,426,227 $ 11,656,677 ============= ============= ==============
See notes to consolidated financial statements. HARVEST STATES COOPERATIVES AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED MAY 31, 1997, 1996, AND 1995 - -------------------------------------------------------------------------------- 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES NATURE OF BUSINESS - Harvest States Cooperatives is a producer-owned agricultural cooperative organized for the mutual benefit of its members. Membership extends from the Midwest to the Pacific Northwest. The Cooperative's primary lines of business are grain marketing, milling, and oilseed processing. Members' grain is marketed through a network of inland and export elevators. Sales are both domestic and international. CONSOLIDATION - The consolidated financial statements include the accounts of Harvest States Cooperatives and its majority-owned subsidiaries (the Company). All significant intercompany balances and transactions have been eliminated. INVENTORIES - Grain and oilseed and processed grain and oilseed products are stated at market, including appropriate adjustment of open purchase, sales, and futures contracts. Feed and farm supply inventories are priced at the lower of cost (first-in, first-out method) or market. The Company follows the general policy of hedging its grain and oilseed inventories and unfilled orders for grain and oilseed products to the extent considered practicable for minimizing risk from market price fluctuations. Futures contracts used for hedging are purchased and sold through regulated commodity exchanges. Inventories, however, are not completely hedged, due in part to the absence of satisfactory hedging facilities for certain commodities and geographical areas and in part to the Company's appraisal of its exposure from expected price fluctuations. Noncommodity exchange purchase and sale contracts may expose the Company to risk in the event that a counterparty to a transaction is unable to fulfill its contractual obligation. The Company manages its risk by entering into purchase contracts with preapproved producers and establishing appropriate limits for individual suppliers. Sales contracts are entered into with organizations of acceptable creditworthiness, as internally evaluated. INVESTMENTS - Investments in cooperatives are stated at cost including allocated equity and retainings. Patronage dividends are recorded at the time written notices of allocation are received. Joint ventures and other significant equity investments are accounted for under the equity method. Under the equity method, the Company recognizes its proportionate share of earnings or loss of the investee. Investments in other debt and equity securities are considered available for sale and are stated at market value, with unrealized amounts included in other equity. PROPERTY, PLANT, AND EQUIPMENT - Property, plant, and equipment are stated at cost, less accumulated depreciation. Depreciation is computed using the straight-line method over the estimated useful lives of the assets. INTANGIBLE ASSETS - Leasehold rights and other intangible assets are amortized using the straight-line method over 3 to 40 years. GRAIN AND OILSEED SALES - Grain and oilseed sales are recorded at time of shipment. Export sales, including those through joint ventures for the years ended May 31, 1997, 1996, and 1995 were as follows: 1997 1996 1995 Africa $ 227,000,000 $ 195,000,000 $ 170,000,000 Asia 2,318,000,000 2,150,000,000 1,080,000,000 Europe 577,000,000 465,000,000 220,000,000 North America 360,000,000 205,000,000 85,000,000 South America 18,000,000 85,000,000 45,000,000 INCOME TAXES - Deferred income taxes are provided on temporary differences between the tax basis of an asset or liability and its reported amount in the financial statements. Due to the high proportion of patronage earnings, deferred taxes resulting from temporary differences are not significant. IMPAIRMENT OF LONG-LIVED ASSETS - Management periodically reviews the carrying value of property and equipment for potential impairment by comparing its carrying value to the estimated undiscounted future cash flows expected to result from the use of these assets. Should the sum of the related, expected future net cash flows be less than the carrying value, an impairment loss would be recognized. An impairment loss would be measured by the amount by which the carrying value of the asset exceeds the fair value of the asset. ESTIMATES - The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. RECLASSIFICATIONS - Certain reclassifications have been made to the 1996 and 1995 consolidated financial statements to conform to the 1997 presentation. These reclassifications have no effect on the operating results of those years, as previously reported.
2. RECEIVABLES Receivables as of May 31: 1997 1996 Trade $ 213,501,012 $ 297,112,614 Elevator accounts 56,172,256 59,163,181 Other 8,819,422 18,003,744 --------------- ---------------- 278,492,690 374,279,539 Less allowance for losses (10,975,000) (7,035,000) --------------- ---------------- $ 267,517,690 $ 367,244,539 =============== ================ 3. INVENTORIES Inventories as of May 31: 1997 1996 Grain and oilseed $ 176,605,333 $ 351,504,342 Processed grain and oilseed products 35,139,534 52,555,945 Feed and farm supplies 36,628,380 30,446,831 --------------- ---------------- $ 248,373,247 $ 434,507,118 =============== ================ 4. INVESTMENTS Investments as of May 31: 1997 1996 Cooperatives: St. Paul Bank for Cooperatives $ 8,666,195 $ 8,180,068 National Bank for Cooperatives 3,546,889 2,855,489 Cenex 16,391,560 12,361,642 Central Ferry Terminal Association 1,222,415 1,222,283 Pro Fac Cooperative 1,789,706 1,769,656 Land O' Lakes, Inc. 7,692,077 3,460,903 Ag Processing, Inc. 16,614,505 14,044,556 Intrade Corporation 1,869,073 1,869,073 Farmland Industries 1,220,261 891,625 Lewis-Clark Terminal, Inc. 1,208,339 1,003,433 Joint Ventures: HSPV, L.L.C. 6,408,265 Tacoma Export Marketing Company 9,163,887 9,330,337 Ventura Foods, L.L.C. 40,505,480 4,651,933 Harvest States - Farmland Specialty Feed 854,678 954,678 Ag States Agency, L.L.C. 5,018,293 4,963,174 Farmland-Harvest States, L.L.C. 1,092,660 Archer Daniels Midland Common Stock 6,213,860 5,770,031 International Malting Company 700,000 700,000 Other 2,777,738 2,832,420 --------------- ---------------- $ 126,547,616 $ 83,269,566 =============== ================
Effective August 30, 1996, the Company transferred certain assets and liabilities of its consumer products packaging division, formerly known as Holsum Foods, for a 40% ownership interest in a joint venture known as Ventura Foods, L.L.C. Simultaneously with the Ventura Foods joint venture agreement, Ventura, a joint venture which was owned 50% by the Company was merged into Ventura Foods, L.L.C. Ventura Foods, L.L.C. is in the business of manufacturing and/or packaging and selling food products, including salad dressings, mayonnaise, margarine, salad oils, jams, jellies, olives, syrups, soup bases, and sauces to a national customer base. Profits and losses are shared in accordance with ownership percentages.
5. OTHER ASSETS Other assets as of May 31: 1997 1996 Leasehold rights and other intangibles, less accumulated amortization of $6,824,986 and $7,145,101 $ 15,232,601 $ 24,908,896 Notes receivable 1,520,511 1,780,474 Prepaid expenses and other assets 29,736,566 21,664,613 ------------------ ----------------- $ 46,489,678 $ 48,353,983 ================== ================= 6. PROPERTY, PLANT, AND EQUIPMENT Property, plant, and equipment as of May 31: Estimated Useful Life in Years 1997 1996 Grain terminals and country elevators 3 to 50 $ 229,171,093 $ 210,151,675 Grain processing plants 3 to 40 163,918,161 199,403,336 Feed plants 3 to 40 24,706,884 23,137,566 Corporate office facilities 3 to 40 12,654,230 11,512,620 ----------------- ----------------- 430,450,368 444,205,197 Less accumulated depreciation (206,299,403) (212,059,796) ----------------- ----------------- $ 224,150,965 $ 232,145,401 ================= =================
During the years ended May 31, 1997, 1996, and 1995, the Company capitalized interest of $588,731, $739,101, and $587,637, respectively. 7. BORROWINGS NOTES PAYABLE: The Company has a seasonal loan agreement of $123,000,000 ($200,000,000 at May 31, 1996) committed with St. Paul Bank for Cooperatives, $9,000,000 and $128,250,000 of which were outstanding on May 31, 1997 and 1996, respectively. The Company has a seasonal loan agreement of $277,000,000 committed with National Bank for Cooperatives, $44,000,000 and $95,750,000 of which were outstanding on May 31, 1997 and 1996, respectively. The Company also has seasonal loan agreements of $150,000,000 committed with commercial banks, $45,000,000 and $100,000,000 of which were outstanding on May 31, 1997 and 1996, respectively. The average weighted interest rates as of May 31, 1997 and 1996 were 5.8% and 6.05%, respectively. Major financial covenants of the seasonal loan agreements provide that (1) the Company will maintain a working capital amount of not less than $100,000,000; (2) the Company shall have consolidated members and patrons' equity of not less than $275,000,000; and (3) the Company shall not have consolidated funded debt to consolidated members and patrons' equity in excess of .80 to 1.00. The Company is also required to maintain investments in the St. Paul Bank for Cooperatives and the National Bank for Cooperatives based upon borrowing levels. Patronage allocations to the Company are used to maintain such required level of investment. No direct cash investment is required. The total unused seasonal loan commitment at May 31, 1997 was $452,000,000.
LONG-TERM DEBT AT MAY 31: 1997 1996 St. Paul Bank for Cooperatives, with fixed and variable interest rates from 6.43% to 8.75%, due in installments through 2007 $ 68,550,333 $ 68,192,000 National Bank for Cooperatives with fixed and variable interest rates from 6.43% to 7.51%, due in installments through 2007 56,458,333 52,500,000 Industrial Development Revenue Bonds, payable through July 2005, interest rate of 7.4% 2,100,000 3,300,000 Capitalized lease obligations with fixed and variable rates, 8.0% to 8.90% at May 31, 1997 5,551,793 6,522,624 Mortgages payable and other 1,798,007 2,114,552 --------------- ---------------- 134,458,466 132,629,176 Less current portion (21,094,774) (13,923,204) --------------- ---------------- $ 113,363,692 $ 118,705,972 =============== ================
Annual maturities of outstanding long-term indebtedness due in years ending after May 31, 1997 are as follows: 1998 $ 21,094,774 1999 17,036,058 2000 18,080,431 2001 13,285,423 2002 13,487,139 2003 and thereafter 51,474,641 8. PATRONS' EQUITY In accordance with the bylaws and by action of the Board of Directors, annual net earnings from patronage sources are distributed to consenting patrons following the close of each year and are based on amounts reportable for federal income tax purposes as adjusted in accordance with the bylaws. The cash portion of this distribution is determined annually by the Board of Directors, with the balance issued in the form of Patronage Certificates. Annual net earnings from sources other than patronage may be added to the Capital Reserve or, upon action by the Board of Directors, allocated to members in the form of Nonpatronage Certificates. The Board of Directors has authorized the redemption of Patronage Certificates held by patrons who are 72 years of age and those held by estates of deceased patrons. The Board of Directors has also authorized the redemption of Nonpatronage Certificates held by estates of deceased patrons. On May 31, 1997, the Company completed an offering for the sale of Equity Participation Units (EPUs) in its Wheat Milling Defined Business Unit and its Oilseed Processing and Refining Defined Business Unit to qualified subscribers. Subscribers were allowed to purchase a portion of their EPUs by exchanging existing patronage certificates. Qualified subscribers are identified as Defined Members or representatives of Defined Members which are persons actually engaged in the production of agricultural products or associations of producers of agricultural products. The purchasers of EPUs have the right and obligation to deliver annually the number of bushels of wheat or soybeans equal to the number of Units held. Beginning in the fiscal year ended May 31, 1998, unit holders will participate in the net patronage sourced income from operations of the applicable defined business unit as patronage refunds. It is the Board of Directors goal to distribute patronage refunds attributable to Equity Participation Units in the form of 75% cash and 25% patrons' equities. Retirement of patrons' equities attributable to EPUs is at the discretion of the Board of Directors, but it is the Board's goal to retire such equity on a revolving basis seven years after declaration. 9. RETIREMENT PLANS The Company has noncontributory defined benefit retirement plans covering substantially all salaried and full-time hourly employees. The retirement plan benefits for salaried employees are based on years of service and the participants' total compensation. Benefits for hourly employees are based on various monthly amounts for each year of credited service. The plans are funded by annual contributions to tax-exempt trusts in accordance with federal law and regulations. Plan assets consist principally of corporate obligations, U.S. Government bonds, money market funds, and immediate participation guarantee contracts. During the year ended May 31, 1995, several participants in a nonqualified supplemental defined benefit plan retired, which resulted in an actuarial loss of a magnitude that required a settlement adjustment to be recorded. Net pension expense for the years ended May 31 consists of the following:
1997 1996 1995 Service cost - benefits earned during the period $ 2,883,242 $ 2,496,711 $ 2,564,115 Interest cost on projected benefit obligation 5,907,204 5,587,377 6,376,612 Actual return on plan assets (2,441,078) (6,860,278) (7,329,046) Net amortization and deferral (4,081,960) 555,130 1,165,499 Benefit plan settlement adjustment 3,020,077 -------------- ------------- -------------- $ 2,267,408 $ 1,778,940 $ 5,797,257 ============== ============= ==============
The funded status of the plans and the amount recognized on the consolidated balance sheet as of May 31 are as follows:
1997 1996 Actuarial present value of benefit obligations: Accumulated benefit obligation, including vested benefits of $75,515,800 and $74,406,137, respectively $ 77,644,611 $ 77,127,866 ============== =============== Projected benefit obligation for service rendered to date $ 78,660,275 $ 81,036,131 Plan assets at fair value 76,348,832 75,743,570 -------------- --------------- Plan assets less than projected benefit obligation (2,311,443) (5,292,561) Unrecognized net loss 27,737,539 25,449,810 Unrecognized transition gain at June 1, 1985 being recognized over 13 years (1,259,030) (2,517,627) Unrecognized prior-service cost (1,330,578) 1,520,901 Additional minimum liability (837,742) (1,098,275) -------------- --------------- Prepaid pension cost $ 21,998,746 $ 18,062,248 ============== ===============
The determination of the actuarial present value of the projected benefit obligation was based on a weighted average discount rate of 7.75% in 1997 and 1996, and 8.25% in 1995 and a rate of increase in future compensation of 5% in 1997, 1996, and 1995. The expected long-term rate of return on plan assets was 8.5% in 1997, 8% in 1996, and 8.5% in 1995. 10. POSTRETIREMENT MEDICAL AND OTHER BENEFITS The Company provides certain health care benefits for retired employees. Employees become eligible for these benefits if they meet minimum age and service requirements and are eligible for retirement benefits. The accrued postretirement medical and other benefits costs which are not funded were as follows at May 31:
1997 1996 Accumulated postretirement benefit obligation (APBO): Retirees $ 4,371,635 $ 2,993,307 Fully eligible active plan participants 775,433 1,019,071 Other active plan participants 3,032,288 3,624,620 ------------- --------------- Total APBO 8,179,356 7,636,998 Unrecognized transition obligation (8,501,474) (9,430,105) Unrecognized net gains 3,526,263 4,059,863 ------------- --------------- Accrued postretirement medical and other benefits cost $ 3,204,145 $ 2,266,756 ============= ===============
The components of the net periodic cost are as follows:
1997 1996 1995 Service cost - benefits earned during the year $ 320,925 $ 337,182 $ 312,814 Interest cost on projected benefit obligation 594,742 548,997 739,055 Amortization of unrecognized gains (147,241) (228,025) (41,435) Amortization of transition obligation 531,392 554,710 554,710 Curtailment cost 205,947 -------------- ------------- -------------- Net periodic postretirement cost $ 1,505,765 $ 1,212,864 $ 1,565,144 ============== ============= ==============
The calculations assumed a discount rate of 7.75% in 1997 and 1996 and a health-care-cost trend rate of 9.5% in 1997, declining to 6.0% in 2004. If the health-care-cost trend rate increased by 1%, the APBO would increase by 6.4% and the service cost and interest cost components would increase by 8.5%. 11. PROVISION FOR INCOME TAXES The provision for income taxes for each of the three years ended May 31 was as follows:
1997 1996 1995 Current provision $ 6,200,000 $ 7,100,000 $ 5,400,000 Deferred - principally federal (200,000) (300,000) -------------- ------------- -------------- Total provision $ 6,200,000 $ 6,900,000 $ 5,100,000 ============== ============= ==============
Deferred income taxes, which are not significant, relate principally to allowances and accruals. A reconciliation of the statutory federal tax rate to the effective rate for each of the three years ended May 31 follows:
1997 1996 1995 Statutory federal income tax rate 35.0% 35.0% 35.0% State and local income taxes, net of federal income tax benefit 4.9 4.3 2.6 Patronage earnings (29.8) (29.6) (27.6) Other .5 2.2 .2 ------ ------ ------ Effective rate 10.6% 11.9% 10.2% ====== ====== ======
12. OTHER REVENUES Years Ended May 31 ---------------------------------------------------- 1997 1996 1995 Storage and handling $ 7,424,823 $ 8,722,537 $ 9,168,022 Service revenues 27,419,350 20,572,679 15,942,394 Commission 5,879,621 6,837,272 6,722,261 Joint venture income 11,598,013 12,517,993 4,025,854 Gain (loss) on sale of property, plant, and equipment (4,612,341) 853,024 1,196,717 Interest income 9,448,433 11,581,221 11,471,627 Other 11,469,653 7,254,797 9,030,109 -------------- -------------- --------------- $ 68,627,552 $ 68,339,523 $ 57,556,984 ============== ============== ===============
13. COMMITMENTS AND CONTINGENCIES At May 31, 1997 and 1996, the Company stored grain and processed grain products for others totaling $61,200,000 and $37,900,000, respectively. Such stored commodities and products are not the property of the Company and therefore are not included in the Company inventory. The Company is a guarantor for lines of credit for related companies totaling $26,000,000, of which $10,200,000 was outstanding as of May 31, 1997. All outstanding loans are current with respective creditors as of May 31, 1997. The Company leases approximately 3,400 rail cars with remaining lease terms of one to ten years. In addition, the Company leases vehicles and various manufacturing equipment. Minimum rental payments due under these operating leases at May 31, 1997, are as follows:
Rail Cars Vehicles Other Total 1998 $ 18,392,444 $ 5,101,208 $ 1,824,548 $ 25,318,200 1999 16,700,959 4,200,139 1,375,291 22,276,389 2000 12,732,283 2,955,712 1,236,772 16,924,767 2001 7,921,650 1,607,004 930,081 10,458,735 2002 5,302,372 725,849 854,202 6,882,423 2003 and thereafter 7,459,280 566,113 3,346,668 11,372,061 ------------- -------------- ------------- --------------- $ 68,508,988 $ 15,156,025 $ 9,567,562 $ 93,232,575 ============= ============== ============= ===============
Total rent expense, net of rail car mileage credits received from the railroad and subleases, was approximately $13,624,000, $12,454,000, and $11,378,000 for the years ended May 31, 1997, 1996, and 1995, respectively. Mileage credits and sublease income were $13,641,000, $7,257,000, and $5,126,000 for the years ended May 31, 1997, 1996, and 1995, respectively. The Company is a party to various lawsuits and administrative proceedings incidental to its business. It is impossible, at this time, to estimate what the ultimate legal and financial liability of the Company will be; nevertheless, management believes, based on the information available to date and the resolution of prior proceedings, that the ultimate liability of all litigation and proceedings will not have a material impact on the financial statements of the Company taken as a whole. 14. SUPPLEMENTAL CASH FLOW STATEMENT INFORMATION Additional information concerning supplemental disclosures of cash flow activities for the years ended May 31 is as follows:
1997 1996 1995 Net cash paid during year for: Interest $ 20,737,222 $ 31,836,722 $ 17,741,969 Income taxes 4,457,322 3,934,688 7,054,563 Significant noncash transactions: Noncash patronage refunds issued from prior year's earnings 30,877,406 25,617,898 23,187,069 Noncash nonpatronage certificates issued from prior year's earnings 6,115,487 7,912,297 1,832,136 Capital equity certificates issued in exchange for elevator properties 4,985,585 8,721,542 Capital equity certificates exchanged for equity participation units 2,035,171
15. FAIR VALUE OF FINANCIAL INSTRUMENTS Statement of Financial Accounting Standards No. 107, DISCLOSURE ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS, requires disclosure of the fair value of all financial instruments to which the Company is a party. All financial instruments are carried at amounts that approximate estimated fair value, except for investments in cooperatives, for which it is not practicable to provide fair value information. INDEPENDENT AUDITORS' REPORT Board of Directors Harvest States Cooperatives Saint Paul, Minnesota We have audited the balance sheets of the Oilseed Processing and Refining Defined Business Unit (the Defined Business Unit), formerly known as Honeymead Products Company, a defined business unit of Harvest States Cooperatives as of May 31, 1997 and 1996 and the related statements of earnings, defined business unit equity, and cash flows for each of the three years in the period ended May 31, 1997. These financial statements are the responsibility of the Defined Business Unit`s management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, such financial statements present fairly, in all material respects, the financial position of the Oilseed Processing and Refining Defined Business Unit at May 31, 1997 and 1996 and the results of its operations and its cash flows for each of the three years in the period ended May 31, 1997 in conformity with generally accepted accounting principles. Deloitte & Touche, LLP August 15, 1997 OILSEED PROCESSING AND REFINING DEFINED BUSINESS UNIT (A DEFINED BUSINESS UNIT OF HARVEST STATES COOPERATIVES) BALANCE SHEETS MAY 31, 1997 AND 1996 - -------------------------------------------------------------------------------- 1997 1996 ASSETS CURRENT ASSETS: Receivables (Note 2) $ 34,169,676 $ 22,795,612 Inventories (Note 3) 22,850,699 26,235,220 Prepaid expenses and deposits 2,310,163 310,692 -------------- --------------- Total current assets 59,330,538 49,341,524 PROPERTY, PLANT, AND EQUIPMENT (Note 4) 33,085,560 24,771,413 -------------- --------------- $ 92,416,098 $ 74,112,937 ============== =============== LIABILITIES AND DEFINED BUSINESS UNIT EQUITY CURRENT LIABILITIES: Due to Harvest States Cooperatives (Note 5) $ 25,584,178 $ 9,482,351 Accounts payable and accrued expenses 13,440,922 11,239,588 -------------- --------------- Total current liabilities 39,025,100 20,721,939 COMMITMENTS AND CONTINGENCIES (Note 10) DEFINED BUSINESS UNIT EQUITY (Note 6) 53,390,998 53,390,998 -------------- --------------- $ 92,416,098 $ 74,112,937 ============== =============== See notes to financial statements. OILSEED PROCESSING AND REFINING DEFINED BUSINESS UNIT (A DEFINED BUSINESS UNIT OF HARVEST STATES COOPERATIVES)
STATEMENTS OF EARNINGS YEARS ENDED MAY 31, 1997, 1996, AND 1995 - -------------------------------------------------------------------------------- 1997 1996 1995 REVENUES: Processed oilseed sales $ 441,737,923 $ 399,271,001 $ 398,095,108 Other (expense) revenue (1,659,881) 1,435,708 1,162,518 --------------- -------------- --------------- 440,078,042 400,706,709 399,257,626 COSTS AND EXPENSES: Cost of goods sold 405,791,384 371,424,566 366,407,451 Marketing, general, and administrative 4,341,904 4,544,763 5,137,663 Interest 321,700 151,500 --------------- -------------- --------------- 410,454,988 376,120,829 371,545,114 --------------- -------------- --------------- EARNINGS BEFORE INCOME TAXES 29,623,054 24,585,880 27,712,512 INCOME TAXES (Note 9) 2,100,000 1,600,000 1,500,000 --------------- -------------- --------------- NET EARNINGS $ 27,523,054 $ 22,985,880 $ 26,212,512 =============== ============== ===============
See notes to financial statements. OILSEED PROCESSING AND REFINING DEFINED BUSINESS UNIT (A DEFINED BUSINESS UNIT OF HARVEST STATES COOPERATIVES) STATEMENTS OF DEFINED BUSINESS UNIT EQUITY - -------------------------------------------------------------------------------- BALANCE AT MAY 31, 1994 $ 53,390,998 Net earnings 26,212,512 Divisional equity distributed (26,212,512) --------------- BALANCE AT MAY 31, 1995 53,390,998 Net earnings 22,985,880 Divisional equity distributed (22,985,880) --------------- BALANCE AT MAY 31, 1996 53,390,998 Net earnings 27,523,054 Defined business unit equity distributed (27,523,054) --------------- BALANCE AT MAY 31, 1997 $ 53,390,998 =============== See notes to financial statements. OILSEED PROCESSING AND REFINING DEFINED BUSINESS UNIT (A DEFINED BUSINESS UNIT OF HARVEST STATES COOPERATIVES)
STATEMENTS OF CASH FLOWS YEARS ENDED MAY 31, 1997, 1996, AND 1995 - -------------------------------------------------------------------------------- 1997 1996 1995 CASH FLOWS FROM OPERATING ACTIVITIES: Net earnings $ 27,523,054 $ 22,985,880 $ 26,212,512 Adjustments to reconcile net earnings to net cash flows: Depreciation and amortization 1,777,475 1,598,965 1,724,844 (Gain) loss on sale of property, plant, and equipment 2,045,150 31,765 (431) Change in assets and liabilities: Receivables (11,374,064) (2,407,691) (568,635) Inventories 3,384,521 (8,980,005) 16,861,993 Prepaid expenses and deposits (1,999,471) 213,459 152,531 Accounts payable and accrued expenses 2,201,334 957,592 482,095 -------------- ------------- -------------- Total adjustments (3,965,055) (8,585,915) 18,652,397 -------------- ------------- -------------- Net cash provided by operating activities 23,557,999 14,399,965 44,864,909 CASH FLOWS FROM INVESTING ACTIVITIES: Proceeds from disposition of property, plant, and equipment 1,000 Acquisition of property, plant, and equipment (12,136,772) (5,991,735) (2,557,886) -------------- ------------- -------------- Net cash used in investing activities (12,136,772) (5,991,735) (2,556,886) CASH FLOWS FROM FINANCING ACTIVITIES: Net borrowings from (repayments to) Harvest States Cooperatives 16,101,827 14,577,650 (16,095,511) Defined business unit equity distributed (27,523,054) (22,985,880) (26,212,512) -------------- ------------- -------------- Net cash used in financing activities (11,421,227) (8,408,230) (42,308,023) -------------- ------------- -------------- INCREASE (DECREASE) IN CASH CASH AT BEGINNING OF PERIOD -------------- ------------- -------------- CASH AT END OF PERIOD $ - $ - $ - ============== ============= =============
See notes to financial statements. OILSEED PROCESSING AND REFINING DEFINED BUSINESS UNIT (A DEFINED BUSINESS UNIT OF HARVEST STATES COOPERATIVES) NOTES TO FINANCIAL STATEMENTS YEARS ENDED MAY 31, 1997, 1996, AND 1995 - -------------------------------------------------------------------------------- 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES ORGANIZATION AND NATURE OF BUSINESS - Harvest States Cooperatives Oilseed Processing and Refining Defined Business Unit (the Defined Business Unit), formerly known as Honeymead Products Company, is a defined business unit of Harvest States Cooperatives (the Company) and is not organized as a separate legal entity. The purpose of the Defined Business Unit is to carry on the operations of the Oilseed Processing and Refining Division. The assets and liabilities of the Defined Business Unit continue to be 100% owned by the Company. The Defined Business Unit operates a single soybean crushing and oil refining plant in Mankato, Minnesota and serves customers throughout the United States. CASH MANAGEMENT - The Defined Business Unit draws all of its cash requirements from and deposits all cash generated with the Company's centralized cash management system. INVENTORIES - Oilseed and processed oilseed products are stated at market, including adjustment for open purchase, sales, and futures contracts and deferral of profit on processed oilseed products. The Defined Business Unit follows the general policy of hedging its oilseed inventories and unfilled orders for oilseed products to the extent considered practicable for minimizing risk from market price fluctuations. Futures contracts used for hedging are purchased and sold through regulated commodity exchanges. Inventories, purchase commitments, and sales commitments however, are not completely hedged, due in part to the absence of satisfactory hedging facilities for certain commodities and geographical areas and in part to the Defined Business Unit's appraisal of its exposure from expected price fluctuations. Noncommodity exchange purchase and sale contracts may expose the Defined Business Unit to risk in the event that a counterparty to a transaction is unable to fulfill its contractual obligation. The Defined Business Unit manages its risk by entering into purchase contracts with preapproved producers and companies and by establishing appropriate limits for individual suppliers. Sales contracts are entered into with organizations of acceptable creditworthiness, as internally evaluated. PROPERTY, PLANT, AND EQUIPMENT - Property, plant, and equipment are stated at cost, less accumulated depreciation. Depreciation is computed using the straight-line method over the estimated useful lives of the assets. IMPAIRMENT OF LONG-LIVED ASSETS - Management periodically reviews the carrying value of property and equipment for potential impairment by comparing its carrying value to the estimated undiscounted future cash flows expected to result from the use of these assets. Should the sum of the related, expected future net cash flows be less than the carrying value, an impairment loss would be recognized. An impairment loss would be measured by the amount by which the carrying value of the asset exceeds the fair value of the asset. DEFINED BUSINESS UNIT EQUITY - The Defined Business Unit's earnings are distributed to the Company at the end of each quarter. All patronage-related liability and capital accounts are maintained at the Company's consolidated level. INCOME TAXES - Earnings generated on oilseed purchased by the Defined Business Unit from nonmembers are characterized as nonpatronage and taxable. Earnings generated on oilseed purchased from the Company are considered to be patronage to the extent of the Company's patronage purchase percentage of that particular commodity; the other portion of those earnings is considered taxable. Due to the high proportion of patronage earnings, deferred taxes resulting from temporary differences are not significant. SALES - Sales of processed oilseeds are recognized upon shipment to customers, net of freight charges. ESTIMATES - The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. REVENUE FROM SIGNIFICANT CUSTOMERS - Sales to two customers accounted for 25% and 11% of total sales for the year ended May 31, 1997. Sales to one customer accounted for 31% and 20% of total sales for the years ended May 31, 1996 and 1995, respectively. 2. RECEIVABLES May 31, --------------------------------- 1997 1996 Trade $ 34,564,676 $ 23,190,612 Less allowance for losses (395,000) (395,000) -------------- --------------- $ 34,169,676 $ 22,795,612 ============== =============== 3. INVENTORIES May 31, --------------------------------- 1997 1996 Oilseed $ 11,740,227 $ 17,141,111 Processed oilseed products 11,110,472 9,094,109 -------------- --------------- $ 22,850,699 $ 26,235,220 ============== ===============
4. PROPERTY, PLANT, AND EQUIPMENT Estimated Useful Life May 31, --------------------------------- in Years 1997 1996 Land $ 630,043 $ 630,043 Elevators, crushing plant, and refinery 15 to 20 21,262,318 21,268,532 Machinery and equipment 5 to 18 46,235,522 41,077,104 Furniture and fixtures 3 to 12 379,363 379,363 Other 5 to 12 99,112 99,112 -------------- --------------- 68,606,358 63,454,154 Less accumulated depreciation (42,576,795) (42,310,640) -------------- --------------- 26,029,563 21,143,514 Construction-in-progress 7,055,997 3,627,899 -------------- --------------- $ 33,085,560 $ 24,771,413 ============== ===============
5. DUE TO HARVEST STATES COOPERATIVES The Defined Business Unit satisfies its working capital needs through borrowings, both long- and short-term, from the Company to the extent the Company's borrowing capacity permits. For the years ended May 31, 1996 and 1995, respectively, interest on short-term borrowings from the Company was charged to the divisions based upon a ratable allocation of the Company's consolidated interest expense related to short-term borrowings based upon working capital employed by each division. This results in an effective borrowing rate that may be different than what the division could obtain on an independent basis. During the year ended May 31, 1997, the Company began charging the Defined Business Unit interest on its daily average of short-term borrowings at a rate equivalent to the weighted average interest rate on short-term borrowings of the Company. On May 31, 1997, the weighted average borrowing rate of the Company's short-term borrowings was 5.8%. Amounts due from the Company will receive interest in the same manner at the same rate. Long-term debt has been allocated by the Company on a specified use basis to its defined business units, generally for capital expenditures. 6. DEFINED BUSINESS UNIT EQUITY On May 31, 1997, the Company completed an offering for the sale of Equity Participation Units (EPUs) in its Oilseed Processing and Refining Defined Business Unit to qualified subscribers. Qualified subscribers are identified as Defined Members or representatives of Defined Members which have been defined as persons actually engaged in the production of agricultural products or associations of producers of agricultural products. The purchasers of EPUs have the right and obligation to deliver annually the number of bushels of soybeans equal to the number of Units held. Beginning in the fiscal year ended May 31, 1998, unit holders will participate in the net patronage sourced income from operations of the Oilseed Processing and Refining Defined Business Unit as patronage refunds. EPUs represent an ownership interest in the Company, not the Defined Business Unit. The assets and liabilities of the Defined Business Unit continue to be 100% owned by the Company. 7. RETIREMENT PLANS The Defined Business Unit, through the Company, has noncontributory defined benefit retirement plans covering substantially all salaried and full-time hourly employees. The retirement plan benefits for salaried employees are based on years of service and the participants' total compensation. Benefits for hourly employees are based on various monthly amounts for each year of credited service. The plans are funded by annual contributions to tax-exempt trusts in accordance with federal law and regulations. Plan assets consist principally of corporate obligations, U.S. Government bonds, money market funds, and immediate participation guarantee contracts. Pension costs billed to the Defined Business Unit for the years ended May 31, 1997, 1996, and 1995 were approximately $147,000, $169,000, and $264,000, respectively. The Defined Business Unit's portion of the actuarial present value or accumulated benefit obligations and net pension assets available for benefits has not been determined. Selected information at May 31 for the Company's plan is as follows:
1997 1996 Accumulated benefit obligation, including vested benefits of $75,515,800 and $74,406,137, respectively $ 77,644,611 $ 77,127,866 Projected benefit obligation for service rendered to date 78,660,275 81,036,131 Plan assets at fair value 76,348,832 75,743,570
The determination of the actuarial present value of the projected benefit obligation was based on a weighted average discount rate of 7.75% in 1997 and 1996, and 8.25% in 1995 and a rate of increase in future compensation of 5% in 1997, 1996, and 1995. The expected long-term rate of return on plan assets was 8.5% in 1997, 8% in 1996, and 8.5% in 1995. 8. POSTRETIREMENT MEDICAL AND OTHER BENEFITS The Defined Business Unit, through the Company, provides certain health care benefits for retired employees. Employees become eligible for these benefits if they meet minimum age and service requirements and are eligible for retirement benefits. The accrued postretirement medical and other benefits costs of the Company that are not funded were as follows at May 31:
1997 1996 Accumulated postretirement benefit obligation (APBO): Retirees $ 4,371,635 $ 2,993,307 Fully eligible active plan participants 775,433 1,019,071 Other active plan participants 3,032,288 3,624,620 ------------- --------------- Total APBO 8,179,356 7,636,998 Unrecognized transition obligation (8,501,474) (9,430,105) Unrecognized net gains 3,526,263 4,059,863 ------------- --------------- Accrued postretirement medical and other benefits cost $ 3,204,145 $ 2,266,756 ============= ===============
The net periodic costs billed to the Defined Business Unit for the years ended May 31, 1997, 1996, and 1995 were approximately $229,000, $197,000, and $238,000, respectively. The calculations assumed a discount rate of 7.75% in 1997 and 1996 and a health care cost trend rate of 9.5% in 1997, declining to 6% in 2004. If the health care cost trend rate increased by 1%, the APBO would increase by 6.4% and the service cost and interest cost components would increase by 8.5%. 9. PROVISION FOR INCOME TAXES Results of operations of the Oilseed Processing and Refining Defined Business Unit are included in the consolidated federal income tax return of the Company. The Company has a policy that provides for the payment of taxes on an individual company basis for each of its defined business units and divisions. No significant deferred income tax provision was recorded by the Defined Business Unit. A reconciliation of the statutory federal tax rate to the effective rate for the years ended May 31, follows:
1997 1996 1995 Statutory federal income tax rate 35.0% 35.0% 35.0% State and local income taxes, net of federal income tax benefit 4.9 4.3 2.6 Patronage earnings (32.6) (35.0) (32.4) Other (.2) 2.2 .2 ------ ------ ------ Effective rate 7.1% 6.5% 5.4% ====== ====== ======
10. COMMITMENTS AND CONTINGENCIES Leases for approximately 339 rail cars with remaining lease terms of one to ten years are used by the Defined Business Unit. Minimum rental payments due under these operating leases at May 31, 1997 are as follows: Year Ending May 31: 1998 $ 1,673,040 1999 1,468,110 2000 1,192,940 2001 920,710 2002 862,200 2003 and thereafter 1,043,400 -------------- $ 7,160,400 ============== Total rent expense, net of rail car mileage credits received from the railroad and subleases, was approximately $1,944,747, $1,832,413, and $1,771,790, for the years ended May 31, 1997, 1996, and 1995, respectively. There are various lawsuits and administrative proceedings incidental to the business of the Defined Business Unit. It is impossible, at this time, to estimate what the ultimate legal and financial liability of the Defined Business Unit will be; nevertheless, management believes, based on the information available to date and the resolution of prior proceedings, that the ultimate liability of all litigation and proceedings will not have a material impact on the financial statements of the Defined Business Unit taken as a whole. At May 31, 1997, the operations of the Defined Business Unit had outstanding oilseed purchase contracts of 1,481,386 bushels at prices ranging from $6.35 per bushel to $8.80 per bushel, and outstanding oil purchase contracts of 253,279,083 pounds at prices ranging from $0.2280 per pound to $0.2582 per pound. In addition, the operations of the Defined Business Unit had outstanding sales contracts totaling approximately $39,443,850. 11. RELATED-PARTY TRANSACTIONS Net sales for the years ended May 31, 1997, 1996, and 1995 included $110,678,770, $124,299,369, and $79,133,437, respectively, to related parties. The operations of the Defined Business Unit purchases a portion all of its soybeans from the Company, a related party. Included in cost of goods sold for the years ended May 31, 1997, 1996, and 1995 were $5,726,038, $3,772,327, and $5,502,705, respectively, of these purchases. Additionally, the Company performs various direct management services and incurs certain costs for its defined business unit and divisions. Such costs, including data processing, office services, and insurance, are charged directly to the defined business units and divisions. Indirect expenses, such as publications, board expense, executive management, legal, finance, and human resources, are allocated to the defined business units and divisions based on approximate usage. Costs allocated to the Oilseed Processing and Refining Defined Business Unit for the years ended May 31, 1997, 1996, and 1995 were $825,000, $750,000, and $1,300,000, respectively. 12. SUPPLEMENTAL CASH FLOW STATEMENT INFORMATION Additional information concerning supplemental disclosures of cash flow activities for the years ended May 31 is as follows:
1997 1996 1995 Net cash paid during year for: Interest $ 321,700 $ 151,500 Income taxes 2,300,000 1,500,000 $ 1,650,000
INDEPENDENT AUDITORS' REPORT Board of Directors Harvest States Cooperatives Saint Paul, Minnesota We have audited the balance sheets of the Wheat Milling Defined Business Unit (the Defined Business Unit), formerly known as Amber Milling Company, a defined business unit of Harvest States Cooperatives, as of May 31, 1997 and 1996 and the related statements of earnings, defined business unit equity, and cash flows for each of the three years in the period ended May 31, 1997. These financial statements are the responsibility of the Defined Business Unit's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, such financial statements present fairly, in all material respects, the financial position of the Wheat Milling Defined Business Unit at May 31, 1997 and 1996 and the results of its operations and its cash flows for each of the three years in the period ended May 31, 1997, in conformity with generally accepted accounting principles. Deloitte & Touche, LLP August 15, 1997 WHEAT MILLING DEFINED BUSINESS UNIT (A DEFINED BUSINESS UNIT OF HARVEST STATES COOPERATIVES)
BALANCE SHEETS MAY 31, 1997 AND 1996 - -------------------------------------------------------------------------------- 1997 1996 ASSETS CURRENT ASSETS: Receivables (Note 2) $ 26,860,772 $ 43,749,134 Inventories (Note 3) 12,271,615 9,308,275 Prepaid expenses and deposits 840,730 149,873 --------------- ---------------- Total current assets 39,973,117 53,207,282 OTHER ASSETS (Note 4) 11,814,555 12,881,236 PROPERTY, PLANT, AND EQUIPMENT (Note 5) 69,130,520 59,233,046 --------------- ---------------- $ 120,918,192 $ 125,321,564 =============== ================ LIABILITIES AND DEFINED BUSINESS UNIT EQUITY CURRENT LIABILITIES: Due to Harvest States Cooperatives (Note 6) $ 22,413,445 $ 31,044,150 Accounts payable and accrued expenses 9,493,405 12,480,342 Current portion of long-term debt (Note 6) 10,005,000 6,344,584 --------------- ---------------- Total current liabilities 41,911,850 49,869,076 LONG-TERM DEBT (Note 6) 51,209,270 47,655,416 COMMITMENTS AND CONTINGENCIES (Note 11) DEFINED BUSINESS UNIT EQUITY (Note 7) 27,797,072 27,797,072 --------------- ---------------- $ 120,918,192 $ 125,321,564 =============== ================
See notes to financial statements. WHEAT MILLING DEFINED BUSINESS UNIT (A DEFINED BUSINESS UNIT OF HARVEST STATES COOPERATIVES)
STATEMENTS OF EARNINGS YEARS ENDED MAY 31, 1997, 1996, AND 1995 - -------------------------------------------------------------------------------- 1997 1996 1995 REVENUES - Processed grain sales $ 199,078,687 $ 173,315,613 $ 119,725,183 COSTS AND EXPENSES: Cost of goods sold 181,565,899 161,293,430 112,690,679 Marketing, general, and administrative 6,749,237 4,471,563 3,834,289 Interest 5,229,669 4,457,797 2,278,544 Other (Note 1) 2,000,000 ------------- ------------- -------------- 195,544,805 170,222,790 118,803,512 ------------- ------------- -------------- EARNINGS BEFORE INCOME TAXES 3,533,882 3,092,823 921,671 INCOME TAXES (Note 10) 300,000 200,000 125,000 ------------- ------------- -------------- NET EARNINGS $ 3,233,882 $ 2,892,823 $ 796,671 ============= ============= ==============
See notes to financial statements. WHEAT MILLING DEFINED BUSINESS UNIT (A DEFINED BUSINESS UNIT OF HARVEST STATES COOPERATIVES) STATEMENTS OF DEFINED BUSINESS UNIT EQUITY - -------------------------------------------------------------------------------- BALANCE AT MAY 31, 1994 $ 27,797,072 Net earnings 796,671 Divisional equity distributed (796,671) --------------- BALANCE AT MAY 31, 1995 27,797,072 Net earnings 2,892,823 Divisional equity distributed (2,892,823) --------------- BALANCE AT MAY 31, 1996 27,797,072 Net earnings 3,233,882 Defined business unit equity distributed (3,233,882) --------------- BALANCE AT MAY 31, 1997 $ 27,797,072 =============== See notes to financial statements. WHEAT MILLING DEFINED BUSINESS UNIT (A DEFINED BUSINESS UNIT OF HARVEST STATES COOPERATIVES)
STATEMENTS OF CASH FLOWS YEARS ENDED MAY 31, 1997, 1996, AND 1995 - -------------------------------------------------------------------------------- 1997 1996 1995 CASH FLOWS FROM OPERATING ACTIVITIES: Net earnings $ 3,233,882 $ 2,892,823 $ 796,671 Adjustments to reconcile net earnings to net cash flows: Depreciation and amortization 4,137,440 3,309,307 2,512,430 Loss on Impairment (Note 1) 2,000,000 Change in assets and liabilities: Receivables 16,888,362 (25,116,058) (3,781,655) Inventories (2,963,340) (2,302,088) 4,387,100 Prepaid expenses, deposits, and other (690,857) (51,007) 55,168 Accounts payable and accrued expenses (2,986,937) 5,063,539 3,854,638 ------------ ------------- -------------- Total adjustments 16,384,668 (19,096,307) 7,027,681 ------------ ------------- -------------- Net cash provided by (used in) operating activities 19,618,550 (16,203,484) 7,824,352 CASH FLOWS FROM INVESTING ACTIVITIES: Acquisition of additional intangibles (475,654) (5,624,405) Acquisition of property, plant, and equipment (14,968,233) (18,080,009) (25,123,131) ------------ ------------- -------------- Net cash used in investing activities (14,968,233) (18,555,663) (30,747,536) CASH FLOWS FROM FINANCING ACTIVITIES: Net (repayments to) borrowings from Harvest States Cooperatives (8,630,705) 17,401,970 8,969,855 Long-term debt borrowings 15,000,000 20,250,000 14,750,000 Principal payments on long-term debt (7,785,730) Defined business unit equity distributed (3,233,882) (2,892,823) (796,671) ------------ ------------- -------------- Net cash (used in) provided by financing activities (4,650,317) 34,759,147 22,923,184 ------------ ------------- -------------- INCREASE (DECREASE) IN CASH CASH AT BEGINNING OF PERIOD ------------ ------------- -------------- CASH AT END OF PERIOD $ - $ - $ - ============ ============= ==============
See notes to financial statements. WHEAT MILLING DEFINED BUSINESS UNIT (A DEFINED BUSINESS UNIT OF HARVEST STATES COOPERATIVES) NOTES TO FINANCIAL STATEMENTS YEARS ENDED MAY 31, 1997, 1996, AND 1995 - -------------------------------------------------------------------------------- 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES ORGANIZATION AND NATURE OF BUSINESS - Harvest States Cooperatives Wheat Milling Defined Business Unit (the Defined Business Unit), formerly known as Amber Milling Company, is a defined business unit of Harvest States Cooperatives (the Company) and is not organized as a separate legal entity. The purpose of the Defined Business Unit is to carry on the operations of the Wheat Milling Division. The assets and liabilities of the Defined Business Unit continue to be 100% owned by the Company. In the year ended May 31, 1995, the Defined Business Unit was operated as a joint venture in which the Company owned a 70% interest. Effective June 1, 1995, the Company purchased the minority interest. The Defined Business Unit operates commercial bakery and semolina flour milling facilities in Rush City, Minnesota; Huron, Ohio; Kenosha, Wisconsin; and Houston, Texas. These mills produce semolina and durum flour, which are the primary ingredients in pasta products and wheat flour in the bakery industry. The Defined Business Unit serves customers throughout the United States. CASH MANAGEMENT - The Defined Business Unit draws all of its cash requirements from and deposits all cash generated with the Company's centralized cash management system. INVENTORIES - Grain and processed grain products are stated at market, including adjustment for open purchase, sales, and futures contracts and deferral of normal profit on processed grain products. The Defined Business Unit follows the general policy of hedging its grain inventories and unfilled orders for grain products to the extent considered practicable for minimizing risk from market price fluctuations. Futures contracts used for hedging are purchased and sold through regulated commodity exchanges. Inventories, purchase commitments, and sales commitments, however, are not completely hedged, due in part to the absence of satisfactory hedging facilities for certain commodities and geographical areas and, in part, to the Defined Business Unit's appraisal of its exposure from expected price fluctuations. Noncommodity exchange purchase and sale contracts may expose the Defined Business Unit to risk in the event that a counterparty to a transaction is unable to fulfill its contractual obligation. The Defined Business Unit manages its risk by entering into purchase contracts with preapproved producers and companies and by establishing appropriate limits for individual suppliers. Sales contracts are entered into with organizations of acceptable creditworthiness, as internally evaluated. PROPERTY, PLANT, AND EQUIPMENT - Property, plant, and equipment are stated at cost, less accumulated depreciation. Depreciation is computed using the straight-line method over the estimated useful lives of the assets. OTHER ASSETS - Leasehold rights and other intangible assets are amortized using the straight-line method over 15 to 18 years. IMPAIRMENT OF LONG-LIVED ASSETS - Management periodically reviews the carrying value of property and equipment for potential impairment by comparing its carrying value to the estimated undiscounted future cash flows expected to result from the use of these assets. Should the sum of the related, expected future net cash flows be less than the carrying value, an impairment loss would be recognized. An impairment loss would be measured by the amount by which the carrying value of the asset exceeds the fair value of the asset. In March of 1997, it was reported that a major customer of the Defined Business Unit was closing five of its ten North American plants. A substantial portion of the production of the Defined Business Unit's Rush City mill (44.4% and 31.5% in 1997 and 1996, respectively) is sold to the plants to be closed. Because of the likelihood of diminished demand for semolina from the Rush City mill, management assessed the carrying amount of the Rush City mill relative to expected future cash flows, and recorded a $2,000,000 charge against earnings during the year ended May 31, 1997. DEFINED BUSINESS UNIT EQUITY - The Defined Business Unit's earnings are distributed to the Company at the end of each quarter. All patronage-related liability and capital accounts are maintained at the Company's consolidated level. INCOME TAXES - Earnings generated on grain purchased by the Defined Business Unit from nonmembers are characterized as nonpatronage and taxable. Earnings generated on grain purchased from the Company are considered to be patronage to the extent of the Company's patronage purchase percentage of that particular commodity; the other portion of those earnings is considered taxable. Due to the high proportion of patronage earnings, deferred taxes resulting from temporary differences are not significant. SALES - Sales of processed grains are recognized upon shipment to customers, net of freight charges. REVENUE FROM SIGNIFICANT CUSTOMERS - Sales to two customers accounted for 23% and 11% of total sales for the year ended May 31, 1997, 24% and 15% for the year ended May 31, 1996, and 17% and 14% for the year ended May 31, 1995. ESTIMATES - The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
2. RECEIVABLES May 31, ---------------------- 1997 1996 Trade $ 26,857,249 $ 43,530,542 Other 324,792 459,530 Less allowance for losses (321,269) (240,938) -------------- --------------- $ 26,860,772 $ 43,749,134 ============== =============== 3. INVENTORIES May 31, ---------------------- 1997 1996 Grain $ 10,556,495 $ 8,327,021 Processed grain products 1,295,324 629,647 Other 419,796 351,607 -------------- --------------- $ 12,271,615 $ 9,308,275 ============== =============== 4. OTHER ASSETS May 31, ---------------------- 1997 1996 Goodwill, less accumulated amortization of $1,188,315 and $781,635, respectively $ 4,911,744 $ 5,318,424 Leasehold rights and other intangibles, less accumulated amortization of $5,144,723 and $4,484,723, respectively 6,902,811 7,562,812 -------------- --------------- $ 11,814,555 $ 12,881,236 ============== =============== 5. PROPERTY, PLANT, AND EQUIPMENT Estimated Useful Life May 31, in Years ---------------------------------- 1997 1996 Land $ 397,726 $ 181,420 Grain processing plants 15 to 45 29,767,710 30,835,636 Machinery and equipment 5 to 20 40,169,184 35,520,073 --------------- ---------------- 70,334,620 66,537,129 Less accumulated depreciation (17,748,631) (14,677,871) --------------- ---------------- 52,585,989 51,859,258 Construction-in-progress 16,544,531 7,373,788 --------------- ---------------- $ 69,130,520 $ 59,233,046 =============== ================
During the years ended May 31, 1997, 1996, and 1995, the Defined Business Unit capitalized interest of $588,731, $739,101 and $587,637, respectively. 6. BORROWINGS DUE TO HARVEST STATES COOPERATIVES: The Defined Business Unit satisfies its working capital needs through borrowings, both long and short-term, from the Company to the extent the Company's borrowing capacity permits. Short-term borrowings of $22,413,445 and $31,044,150 were outstanding on May 31, 1997 and 1996, respectively. For the years ended May 31, 1996 and 1995, respectively, interest on short-term borrowings from the Company was charged to the divisions based upon a ratable allocation of the Company's consolidated interest expense related to short-term borrowings based upon working capital employed by each division. This results in an effective borrowing rate that may be different than what the division could obtain on an independent basis. During the year ended May 31, 1997, the Company began charging the Defined Business Unit interest on its daily average of short-term borrowings at a rate equivalent to the weighted average interest rate on short-term borrowings of the Company. On May 31, 1997, the weighted average borrowing rate of the Company's short-term borrowings was 5.8%. Amounts due from the Company will receive interest in the same manner at the same rate.
May 31, -------------------------------- 1997 1996 Harvest States Cooperatives, with fixed and variable interest rates from 6.43% to 8.75%, due in installments through 2005 $ 59,114,270 $ 51,700,000 Industrial Development and Public Grain Elevator Revenue Bonds, payable through July 2004, with an interest rate of 7.4% 2,100,000 2,300,000 -------------- --------------- 61,214,270 54,000,000 Less current portion (10,005,000) (6,344,584) -------------- --------------- $ 51,209,270 $ 47,655,416 ============== ===============
The principal maturities of outstanding long-term indebtedness outstanding at May 31, 1997 are as follows: Year ending May 31: 1998 $ 10,005,000 1999 10,005,000 2000 10,005,000 2001 8,130,000 2002 7,120,000 2003 and thereafter 15,949,270 7. DEFINED BUSINESS UNIT EQUITY On May 31, 1997, the Company completed an offering for the sale of Equity Participation Units (EPUs) in its Wheat Milling Defined Business Unit to qualified subscribers. Qualified subscribers are identified as Defined Members or representatives of Defined Members which have been defined as persons actually engaged in the production of agricultural products or associations of producers of agricultural products. The purchasers of EPUs have the right and obligation to deliver annually the number of bushels of wheat equal to the number of Units held. Beginning in the fiscal year ended May 31, 1998, unit holders will participate in the net patronage sourced income from operations of the Wheat Milling Defined Business Unit as patronage refunds. EPUs represent an ownership interest in the Company not the Defined Business Unit. The assets and liabilities of the Defined Business Unit continue to be 100% owned by the Company. 8. RETIREMENT PLANS The Defined Business Unit, through the Company, has noncontributory defined benefit retirement plans covering substantially all salaried and full-time hourly employees. The retirement plan benefits for salaried employees are based on years of service and the participants' total compensation. Benefits for hourly employees are based on various monthly amounts for each year of credited service. The plans are funded by annual contributions to tax-exempt trusts in accordance with federal law and regulations. Plan assets consist principally of corporate obligations, U.S. Government bonds, money market funds, and immediate participation guarantee contracts. Pension costs billed to the Defined Business Unit for 1997, 1996, and 1995 were approximately $136,000, $46,000, and $101,000, respectively. The Defined Business Unit's portion of the actuarial present value or accumulated benefit obligations and net pension assets available for benefits has not been determined. Selected information at May 31 for the Company's plan is as follows:
1997 1996 Accumulated benefit obligation, including vested benefits of $75,515,800 and $74,406,137, respectively $ 77,644,611 $ 77,127,866 Projected benefit obligation for services rendered to date 78,660,275 81,036,131 Plan assets at fair value 76,348,832 75,743,570
The determination of the actuarial present value of the projected benefit obligation was based on a weighted average discount rate of 7.75% in 1997 and 1996 and 8.25% in 1995 and a rate of increase in future compensation of 5% in 1997, 1996, and 1995. The expected long-term rate of return on plan assets was 8.5% in 1997, 8% in 1996, and 8.5% in 1995. 9. POSTRETIREMENT MEDICAL AND OTHER BENEFITS The Defined Business Unit, through the Company, provides certain health care benefits for retired employees. Employees become eligible for these benefits if they meet minimum age and service requirements and are eligible for retirement benefits. The accrued postretirement medical and other benefits costs of the Company that are not funded were as follows at May 31:
1997 1996 Accumulated postretirement benefit obligation (APBO): Retirees $ 4,371,635 $ 2,993,307 Fully eligible active plan participants 775,433 1,019,071 Other active plan participants 3,032,288 3,624,620 ------------- -------------- Total APBO 8,179,356 7,636,998 Unrecognized transition obligation (8,501,474) (9,430,105) Unrecognized net gains 3,526,263 4,059,863 ------------- -------------- Accrued postretirement medical and other benefits cost $ 3,204,145 $ 2,266,756 ============= ==============
The net periodic costs billed to the Defined Business Unit for 1997, 1996, and 1995 were approximately $65,000, $42,000, and $44,000, respectively. The calculations assumed a discount rate of 7.75% in 1997 and 1996 and a health care cost trend rate of 9.5% in 1997, declining to 6% in 2004. If the health care cost trend rate increased by 1%, the APBO would increase by 6.4% and the service cost and interest cost components would increase by 8.5%. 10. PROVISION FOR INCOME TAXES Results of operations of the Wheat Milling Defined Business Unit are included in the consolidated federal income tax return of the Company. The Company has a policy that provides for the payment of taxes on an individual company basis for each of its defined business units and divisions. No significant deferred income tax provision was recorded by the Defined Business Unit. A reconciliation of the statutory federal tax rate to the effective rate for the years ended May 31 follows:
1997 1996 1995 Statutory federal income tax rate 35.0% 35.0% 35.0% State and local income taxes, net of federal income tax benefit 4.9 4.3 2.6 Patronage earnings (31.2) (35.6) (24.2) Other (.2) 2.8 .2 ------ ------ ------ Effective rate 8.5% 6.5% 13.6% ====== ====== ======
11. COMMITMENTS AND CONTINGENCIES Leases for approximately 242 rail cars with remaining lease terms of one to ten years are used by the Defined Business Unit. In addition, leases for a milling facility, certain vehicles, and various manufacturing equipment are used by the Defined Business Unit. Minimum rental payments due under these operating leases at May 31, 1997 are as follows:
Milling Rail Cars Facility Other Total Years ending May 31: 1998 $ 1,682,625 $ 426,668 $ 42,384 $ 2,151,677 1999 1,549,590 440,004 32,902 2,022,496 2000 1,503,855 440,004 19,190 1,963,049 2001 1,279,020 440,004 2,645 1,721,669 2002 379,255 440,004 819,259 2003 and thereafter 2,546,668 2,546,668 ------------- -------------- ------------- --------------- $ 6,394,345 $ 4,733,352 $ 97,121 $ 11,224,818 ============= ============== ============= ===============
Total rent expense, net of rail car mileage credits received from the railroad and subleases, was approximately $2,144,838, $1,624,576, and $1,180,836 for the years ended May 31, 1997, 1996, and 1995, respectively. Mileage credits and sublease income were $375,667, $338,700, and $321,909 for the years ended May 31, 1997, 1996, and 1995, respectively. There are various lawsuits and administrative proceedings incidental to the business of the Defined Business Unit. It is impossible, at this time, to estimate what the ultimate legal and financial liability of the Defined Business Unit will be; nevertheless, management believes, based on the information available to date and the resolution of prior proceedings, that the ultimate liability of all litigation and proceedings will not have a material impact on the financial statements of the Defined Business Unit taken as a whole. At May 31, 1997, the operations of the Defined Business Unit had outstanding grain purchase contracts of approximately 5,100,000 bushels at prices for durum ranging from $5.06 per bushel to $6.00 per bushel and prices for spring wheat ranging from $3.79 per bushel to $5.37 per bushel. In addition, the operations of the Defined Business Unit had outstanding sales contracts of both semolina and commercial baking flour totaling approximately $40,714,000. 12. RELATED-PARTY TRANSACTIONS Net sales for the year ended May 31, 1997, 1996, and 1995 included $753,583, $647,416, and $321,768, respectively, to related parties. The operations of the Defined Business Unit purchases substantially all of its durum and wheat from the Company, a related party. Included in cost of goods sold for the years ended May 31, 1997, 1996, and 1995 were $138,000,000, $122,900,000, and $69,900,000, respectively, of these purchases. Additionally, the Company performs various direct management services and incurs certain costs for its defined business units and divisions. Such costs, including data processing, office services, and insurance, are charged directly to the defined business units and divisions. Indirect expenses, such as publications, board expense, executive management, legal, finance, and human resources, are allocated to the defined business units and divisions based on approximate usage. Costs allocated to the Wheat Milling Defined Business Unit for the years ended May 31, 1997, 1996, and 1995 were $1,000,000, $950,000, and $1,100,000, respectively. 13. SUPPLEMENTAL CASH FLOW STATEMENT INFORMATION Additional information concerning supplemental disclosures of cash flow activities for the years ended May 31 is as follows:
1997 1996 1995 Net cash paid during year for: Interest $ 5,229,669 $ 4,457,797 $ 2,278,544 Income taxes 300,000 125,000 150,000
EX-10.5A 2 AMENDMENT NO. 1 TO PARTNERSHIP AGREEMENT AMENDMENT NO. 1 TO PARTNERSHIP AGREEMENT BETWEEN CONTINENTAL GRAIN COMPANY ["CONTINENTAL"] AND HARVEST STATES COOPERATIVES ["HARVEST STATES"] [THE PARTNERSHIP AGREEMENT] This Amendment No. 1 to the Partnership Agreement dated as of September 28, 1992 is made effective June 1, 1997 by and between Continental and Harvest States. WHEREAS, Continental and Harvest States desire to amend the Partnership Agreement in accordance with the terms of this Amendment No. 1. NOW, THEREFORE, Continental and Harvest States agree as follows: 1. All capitalized terms used herein, unless otherwise defined herein, have the same meaning given to them in the Partnership Agreement. 2. Paragraph 2.4 of the Partnership Agreement is hereby amended to read as follows: "2.4 Duration. The Partnership shall commence on September 15, 1992 and shall continue through the close of business on May, 31 2002, unless sooner terminated as provided herein. The term of the Partnership shall be extended automatically for three [3] successive five [5] year periods unless either Partner delivers written notice to the other Partner not less than one hundred eighty [180] days prior to the expiration of the then current term that it elects not to renew or extend the term of the Partnership. In no event, however, shall the term of the Partnership continue beyond 2017 without the written agreement of both Partners." 3. Section 5.4 of the Partnership Agreement is hereby amended to read as follows: "5.4 Deadlock. If the Management Committee cannot agree on any Fundamental Issue within thirty [30] days following the Management Committee meeting at which a decision on such Fundamental Issue was sought, or within thirty [30] days of any such Fundamental Issue being submitted to the members of the Management Committee for approval, then such matter shall be submitted to the Chief Executive Officer of Harvest States Cooperatives and the Chief Executive Officer of Continental Grain Company to resolve. If the above mentioned executives of the Partners are unable to resolve such deadlocked Fundamental Issue within thirty [30] days following submission of the matter to them for resolution, then the matter shall be submitted to arbitration in accordance with Section 12.2 of this Partnership Agreement." 4. Section 5.5 of the Partnership Agreement is hereby amended to read as follows: "5.5 Subcommittees. The Management Committee shall appoint such subcommittees as it deems advisable, each with an equal number of representatives from each Partner." 5. The first sentence of Section 6.1[a] of the Partnership Agreement is deleted and replaced in its entirety by the following: "The General Manager shall be a Continental employee so long as the administration and trading functions of the Partnership are predominantly operated out of Harvest States' facilities. If the Partnership's administration and trading functions are moved to any Continental facility, the General Manager shall be an employee of Harvest States." 6. The last sentence of Section 6.1[a] is hereby amended to read as follows: "...The General Manager shall enter into transactions on behalf of the Partnership except that the General Manager is not authorized to take any action on a Fundamental Issue unless such action shall have been approved by the Management Committee pursuant to Section 5.2[c]." 7. The Partnership Agreement is hereby amended by adding the following two [2] sections under Article VIII. NATURE OF OBLIGATIONS; INDEMNITIES; CHARGES: "8.4 Administrative Expenses. The expenses incurred by Continental in it's Portland, Oregon office to provide the Partnership with export administration support shall be provided at no cost to the Partnership. Similarly, the expenses incurred by Harvest States in it's St. Paul, Minnesota office to provide the Partnership with accounting and trading administrator support shall be provided at no cost to the Partnership." "8.5 Insurance. The Partnership shall purchase and maintain commercial general liability and property insurance on the Tacoma Facility and other insurance coverages, with deductibles and limits, as established and approved by the Management Committee. Initially, the Management Committee establishes and approves the insurance with the coverages, limits and deductibles set forth on the Certificates of Insurance attached hereto as Exhibit A. The coverages, limits and deductibles shall not be changed without the approval of the Management Committee." 8. Section 11.1[b] of the Partnership Agreement is deleted in it entirety and replaced with the following: "[b] If either Partner requests dissolution in writing within thirty [30] days of the sale, assignment or transfer of any Strategic Asset to the other Partner or to a third party pursuant to Section 19.10 of this Agreement." 9. Section 11.2 of the Partnership Agreement is hereby amended by adding the following subparagraphs [e] and [f]: "[e] In conjunction with dissolution and liquidation of the Partnership, Continental shall pay to the Partnership the then book value [net of accumulated depreciation] of all capital improvements and/or repairs made by the Partnership to the Tacoma Facility during the term of the Partnership and which have been authorized to be made by the Management Committee. [f] In conjunction with dissolution and liquidation of the Partnership, the shares of the Bank of Cooperatives (the "COBANK") held by the Partnership shall be distributed equally to the Partners; provided, however, that in the event that COBANK will not transfer the Partnership's shares in COBANK stock to Continental, then Harvest States will purchase all of the COBANK shares owned by the Partnership from the Partnership at the Net Present Value [NPV] of the stated carrying value of such shares as expressed on the Partnership's financial statements. It being understood that the NPV would be computed based upon the cash payout formula for stock redemption in use by COBANK at the date of the dissolution. The discount factor to be used for calculating the NPV would be 100 basis points over the applicable United States Treasury Note rate for the cash payout period." 10. The third sentence of Section 12.2 of the Partnership Agreement is hereby amended to read as follows: "Conditions of any such arbitration shall include [a] that the arbitrators shall not have the authority to modify, amend or supplement the terms of this Agreement, and shall interpret this Agreement strictly in accordance with its terms; [b] that the amount of capital required to be contributed by a Partner to the Partnership shall not be increased; and [c] that the Partner submitting such controversy or dispute to arbitration shall appoint its arbitrator within fifteen [15] Business Days after the date of such submission." 11. The Partnership Agreement is hereby amended by adding the following Section 19.10: "19.10 First and Last Rights of Refusal. This provision will apply under either of the below circumstances: [a] Continental wishes to sell, transfer, sublease or assign the Tacoma Facility to a third party [whether a corporation, partnership, or individual]; or [b] Harvest States wishes to sell, transfer, sublease or assign any of the Line Elevators, set forth in Exhibit B hereto, to a third party [whether a corporation, partnership or individual] who directly or indirectly operates a grain elevator in the Pacific Northwest for the export of corn and/or soybeans. For the purposes of this Agreement, the Tacoma Elevator and the Line Elevators set forth in Exhibit B, shall be individually and collectively known as the "Strategic Asset[s]". When either of the above events occurs [the "Proposed Transfer"], the applicable Partner shall provide the other Partner with at least thirty [30] days prior written notice. During such thirty [30] day period the Partner receiving such notice shall have the first right to acquire the Strategic Assets being disposed. The Partners shall negotiate the terms and conditions of such acquisition in good faith. If the Partners are unable to reach agreement on the terms of such Proposed Transfer within such thirty [30] day period, the other Partner shall be free to proceed with the Proposed Transfer of its interest in the Strategic Asset to a third party, provided that the Partner divesting the Strategic Assets shall provide the other Partner with at least thirty [30] days prior written notice of a Proposed Transfer to any third party, which notice shall contain the terms and conditions of the Proposed Transfer along with any documents or agreements relating thereto. The other Partner shall then have the right [the "Last Right"] during such thirty [30] day period to match the terms of the Proposed Transfer by sending written notice thereof to the other Partner within such thirty [30] day period. If the Partner receiving such notice exercises its Last Right, the Proposed Transfer shall be made upon the same terms and conditions contained in the written notice. If the Partner receiving such notice fails to exercise its Last Right within such thirty [30] day period, the other Partner shall be free to transfer its interest in the Strategic Assets on the original terms and conditions of the Proposed Transfer. If the Proposed Transfer is not consummated within the following ninety [90] day period, or the terms and conditions of the Proposed Transfer are changed, it and all subsequent Proposed Transfers shall again become subject to the terms of this Section. For this purpose Strategic Assets are defined to include the Tacoma Facility and the Line Elevators owned and operated by Harvest States as set forth in Exhibit B, attached hereto." 12. The Partnership Agreement is hereby amended by adding the following section under Article XIII CONFIDENTIAL INFORMATION: "13.2 Non-Solicitation Clause. During the duration of this Agreement each Partner represents that it will not initiate employment discussions with personnel employed by the other Partner by direct contact or through executive search firms, employment agencies, or other indirect means, for so long as such personnel is employed by the Partner and for an additional six [6] months after such personnel leaves that Partner's employ. It being understood that this would not apply in instances where personnel from either Partner are responding to general advertisements of job openings." 13. Except as amended above, the remaining terms and conditions of the Partnership Agreement shall remain in full force and effect. IN WITNESS WHEREOF, the undersigned have executed this Amendment No. 1 effective as of June 1, 1997. HARVEST STATES COOPERATIVES By: /s/ Michael H. Bergeland ------------------------------------ Its: Group Vice President ------------------------------- Grain & Agri Services CONTINENTAL GRAIN COMPANY By: /s/ John Zick ------------------------------------ Its: Sr. VP/& General Manager ------------------------------- North American Grain Division EXHIBIT B Farm Marketing & Supply Unit Train Facilities Marshall, MN Ruthton, MN Morris, MN West Fargo, ND Mooreton, ND French (Fergus Falls), MN Milbank, SD Groton, SD Lowry (Soo Line), MN Galchutt, ND Canton, SD Corson, SD Wentworth, SD Mitchell, SD EX-10.16 3 LEASE AGREEMENT LEASE AGREEMENT THIS LEASE AGREEMENT is entered into as of the date set forth on the signature page hereof between the LACKAWANNA COUNTY RAILROAD AUTHORITY, a Municipal corporation of the Commonwealth of Pennsylvania, (the "Landlord"), and AMBER MILLING COMPANY, A DIVISION OF HARVEST STATES COOPERATIVES, a Minnesota cooperative corporation, to be addressed at 1667 North Snelling Avenue, P.O.Box 64594, St. Paul, Minnesota 55164 (the "Tenant"). RECITALS WHEREAS, Landlord desires to lease to Tenant, and Tenant desires to lease from Landlord, the approximately 42 acre site owned by Landlord and legally described on the attached EXHIBIT A. AGREEMENTS NOW, THEREFORE, in consideration of the mutual agreements herein set forth, Landlord and Tenant agree as follows: ARTICLE 1. DEFINITIONS. As used in this Lease, the following (in addition to the terms defined elsewhere herein), and whether singular or plural thereof, shall have the following meanings when used herein with initial capital letters: "Awards shall mean any payment or other compensation received or receivable from or on behalf of any governmental authority or any person or entity vested with the power of eminent domain for or as a consequence of any Taking. "Commencement Date" shall mean May 1, 1997. "Completion Date" shall mean the date that the Project is complete, commissioned and ready for operation in accordance with its specifications. "Compatible Parcel" shall mean that part of the Leased Premises which is not necessary for the efficient operation of the Project and which is subject to the terms of Article 9 of this Lease. "D-L" shall mean the Delaware-Lackawanna Railroad Co., Inc., its successors and assigns. "D-L Agreement" shall mean the transportation contract between D-L and Tenant providing for rail transportation services to be performed by D-L for the Project. "Excluded Property" shall mean the machinery and equipment described on EXHIBIT "B", including all replacements, enhancements, accessions or substitutions thereof or thereto, and all other personal property, office supplies, moveable office furniture and other property constituting trade fixtures not attached to or constituting a part of the Leased Premises. "Force Majeure" shall mean: (a) acts of God, landslides, lightning, earthquakes, hurricanes, tornadoes, blizzards, fires, explosions, floods, acts of a public enemy, wares, blockades, insurrections, riots or civil disturbances; (b) labor disputes, strikes, work slowdowns, or work stoppages (excluding, however, those of Tenant's or Landlord's employees); and (c) any other similar cause or event, provided that the foregoing is beyond the reasonable control of the party claiming Force Majeure. "Hazardous Materials" shall have the meaning ascribed to it in Section 4.03 hereof. "Impositions" shall mean (a) all real estate, personal property, rental, water, sewer, transit, use, occupancy and other taxes, assessments, charges, excises and levies which are imposed upon or with respect to (i) the Leased Premises or any portion thereof, or the sidewalks, streets or alley ways adjacent thereto, or the ownership, use, occupancy or enjoyment thereof, or (ii) this Lease and the Rent payable hereunder; and (b) all charges for any easement, license, permit or agreement maintained for the benefit of the Leased Premises. "Landlord" shall mean the Lackawanna County Railroad Authority identified in the opening recital of this Lease, and its successors and assigns and subsequent owners of the Leased Premises. "Lease" shall mean this Lease as amended in accordance with Section 20.07. "Lease Year" shall mean the period from May 1st of each year through April 30th of the following year. "Leased Premises" shall mean (a) the property leased by Tenant pursuant to this Lease as further described in EXHIBIT "A" hereto and (b) the Project; excluding, however, the Excluded Property. "Legal Requirements" shall mean any and all (a) judicial decisions, orders, injunctions, writes, statutes, rulings, rules, regulations, promulgations, directives, permits, certificates or ordinances of Leased Premises, including zoning, environmental and utility conservation matters, (b) insurance requirements, and (c) other written documents, instruments or agreements relating to the Leased Premises or to which the Leased Premises may be bound or encumbered (as of the Commencement Date) and copies of which have been provided to Tenant. "Permitted Use" shall mean grain milling and its products and the byproducts thereof, and the manufacture of any products using milled products, by products and additives, together with all other related business uses. "Project" shall mean the mill, warehouse, elevator and other improvements to be constructed by Tenant together with all alterations, improvements and additions to and replacements of such improvements, and shall include the Excluded Property. "Rent" shall mean Base Rent, Additional Rent and all other amounts provided for under this Lease to be paid by Tenant, whether as additional rent or otherwise. "Base Rent" shall have the meaning ascribed to it in Section 5.01. "Additional Rent" shall have the meaning ascribed to it in Section 5.02. "Taking" shall mean the taking, damaging or destroying of all or any portion of the Leased Premises by or on behalf of any governmental authority or any other person or entity pursuant to its power of eminent domain. "Total Taking" shall mean any Taking of all or substantially all of the Leased Premises, or of so much of the Leased Premises that the portion remaining cannot, in Tenant's good faith judgment reasonably exercised, be economically restored. "Partial Taking" shall mean any Taking of less than all of the Leased Premises such that the portion remaining can, in Tenant's good faith judgment reasonably exercised, be economically restored. "Tenant" shall mean Amber Milling Company, a division of Harvest States Cooperatives the tenant identified in the opening recital of this Lease and its permitted Transferees which succeed to the leasehold estate created thereby. "Term" shall mean the effective period of this Lease, as described in Article 3 hereof. "Transfer" shall mean (a) an assignment (direct or indirect, absolute or conditional, by operation of law or otherwise) by Tenant of all or any portion of Tenant's interest in this Lease or the leasehold estate created hereby, (b) a sublease of all or any portion of the Leased Premises or (c) the grant or conveyance by Tenant of any concession or license within the Leased Premises. If Tenant is a corporation then any transfer of the Lease by merger, consolidation or dissolution. "Transferee" shall mean the assignee, sublessee, pledgee, concessionee, licensee or other transferee of all or any portion of Tenant's interest in this Lease, the leasehold estate created hereby or the Leaded Premises. ARTICLE 2. LEASED PREMISES. Subject to the provisions of this Lease, Landlord hereby leases, demises and lets to Tenant, and Tenant hereby leases from Landlord, the Leased Premises. ARTICLE 3. TERM. The Term of this Lease shall commence on the Commencement Date and shall (subject to earlier termination as herein provided) continue for a period of Forty (40) years thereafter. ARTICLE 4. USE. Section 4.01. Permitted Use. Tenant will occupy and use the Leased Premises solely for the Permitted Use and in strict compliance with all Legal Requirements. Section 4.02. Specifically Prohibited Use. Tenant will not (a) use, occupy or permit the use or occupancy of the Leased Premises for any purpose or in any manner which is or may be directly or indirectly (i) inconsistent with the requirements of Section 4.01 hereof, (ii) violative of any of the Legal Requirements, (iii) dangerous to life, health, the environment or property, or a public or private nuisance, or (iv) disruptive to the activities of any other tenant or occupant of property adjacent to the Leased Premises, (b) commit or permit to remain any waste to the Leased Premises, or (c) commit, or permit to be committed, any action or circumstance in or about the Lease Premises which, directly or indirectly, would or might justify any insurance carrier in cancelling the insurance policies maintained by Tenant or Landlord on the Leased Premises and improvements thereon. Section 4.03. Environmental Restrictions. Tenant shall not cause or permit any Hazardous Materials to be generated, treated, stored on or about the Leased Premises or transferred to the Leased Premises in contravention of any other Legal Requirement. Any use of Hazardous Materials by any person on the Leased Premises shall be in strict conformance with all Legal Requirements and shall not cause the Leased Premises to be subject to remedial obligations to protect health or the environment. The term "Hazardous Materials" shall mean any flammables, explosives, radioactive materials, hazardous waste, toxic substances or related materials, including substances defined as "hazardous substances", "hazardous materials", "toxic substances", or "solid waste" in the Comprehensive Environmental Response, Compensation and Liability Act of 1980, as amended, 42 U.S.C. Sec. 9601, et seq.; the Hazardous Materials Transportation Act, 49 U.S.C. Sec. 1801, et seq.; the Resources Conservation and Recovery Act, 42 U.S. C. Sec. 6901, et seq.; and Toxic Substance Control Act, as amended, 15 U.S.C. Sec. 2601 et seq.; or any other Legal Requirement. ARTICLE 5. RENT. Section 5.01. Base Rent. In consideration of Landlord's leasing the Leased Premises to Tenant, Tenant shall pay to Landlord, commencing as of the Commencement Date, base rent of One Dollar ($1.00) per year. Section 5.02. Additional Rent. Tenant shall pay to the appropriate party or to Landlord, as Additional Rent, any and all Impositions affecting the Leased Property. Section 5.03. Payment of Rent. Except as otherwise expressly provided in this Lease, all Base Rent shall be due and payable in advance annual installments on the first day of each Lease Year during the Term. The Additional Rent shall be due and payable in accordance with the terms thereof. Rent shall be paid to Landlord at its address for notice hereunder or to such other person or at such other address as Landlord may from time to time designate in writing. Rent shall be paid in legal tender of the United States of America without notice, demand, abatement, deduction or offset. ARTICLE 6. CONSTRUCTION, OWNERSHIP AND OPERATION OF THE PROJECT. Section 6.01. The Project. Subject to delays caused by Force Majeure, Tenant shall complete, at its sole cost and expense, the Project. Tenant shall construct the Project in a good and workmanlike manner and in compliance with the then effective applicable Building Codes and all applicable Legal Requirements. Tenant shall test all fill used in construction of the Project for the presence of Hazardous Materials. Tenant shall provide a copy of all test results to Landlord. Section 6.02. Alterations and Improvements. Tenant shall have the right to make alterations, additions, or improvements to the Leased Premises or the Project, including constructing or improving buildings. Such alterations, additions and improvements shall be done at Tenant's cost and expense and in a good and workmanlike manner. Section. 6.03. Permits. Tenant shall obtain and maintain in effect at all times during the Term all permits, license and consents required or necessary of the construction, installation, maintenance, use and operation of the Project and Tenant's use and occupancy of and operations at the Leased Premises. Section. 6.04. Ownership and Removal of the Excluded Property. The Project (including the Excluded Property) shall constitute Tenant improvements, provided that the Project (excluding the Excluded Property) shall be surrendered with the Leased Premises as part thereof at the expiration or earlier termination of the Term without any payment, reimbursement or compensation therefor. Tenant shall remove the Excluded Property upon the expiration or earlier termination of the Term and Tenant shall repair all damage to the Leased Premises caused by such removal. If Tenant fails to remove the Excluded Property within 240 days following the expiration or earlier termination of the Term, then at Landlord's election, (x) Tenant's rights, title and interest in and to such Excluded Property shall be vested in Landlord (without the necessity of executing any conveyance instruments) or (y) Landlord shall be entitled to remove and store such Excluded Property at Tenant's expense. If Landlord is required by Legal Requirements to remove the Project from the Leased Premises upon or at any time within five (5) years after the termination of the Lease, Tenant shall remove the Project at its sole cost and expense. Section 6.05. Condition of Leased Premises. Tenant acknowledges that Tenant has independently and personally inspected the Leased Premises and that Tenant has entered into this Leased based upon such examination and inspection. Except for the warranties contained in Article 16, Tenant accepts the Leased Premises in its present condition, "AS IS, WITH ALL FAULTS, IF ANY, AND WITHOUT ANY WARRANTY WHATSOEVER, EXPRESS OR IMPLIED;" specifically (without limiting the generality of the foregoing) without any warranty of (a) the nature or quality of any construction, structural design or engineering of any improvements currently located at or constituting a portion of the Leased Premises, (b) the quality of the labor and materials included in any such improvements, or (c) the suitability of the Leased Premises for any particular purpose or developmental potential. Landlord shall not be required to make any improvements to the Leased Premises or to repair any damages to the Leased Premises or to pay for any environmental remediation or cleanup expenses on the Leased Premises. Section 6.06. Repair and Maintenance. Tenant shall maintain the Leased Premises at all times during the Term in as good, clean, safe, operable and well-kept condition as at the Commencement Date, and will not commit or allow to remain any waste or damage to any portion of the Leased Premises. Section 6.07. Laborers and Mechanics. Tenant shall pay for all labor and services performed for, materials used by or furnished to Tenant, or used by or furnished to any contractor employed by Tenant with respect to the Leased Premises and hold Landlord and the Leased Premises harmless and free from any liens, claims, encumbrances or judgments created or suffered by Tenant. If Tenant elects to post a payment or performance bond or is required to post an improvement bond with a public agency in connection with the above, Tenant agrees to include Landlord as an additional obligee thereunder. ARTICLE 7. LANDLORD'S CONTRIBUTION TO PROJECT. Landlord agrees to make available to Tenant a PENNDOT Grant of up to a maximum of Seven Hundred Thirteen Thousand Six Hundred Thirty Seven and No/100 Dollars ($713,637.00) for infrastructure improvements subject to PENNDOT approval. Infrastructure improvements may include the following: (i) road construction and improvements (including any public road improvements, traffic lights, or other improvements related thereto); (ii) construction of utilities to serve the Project (including, without limitation, electrical, sanitary sewer, storm sewer or drainage, water, natural or propane gas) and the purchase of any equipment in connection therewith; and (iii) rail or rail related purchase and construction. Notwithstanding the foregoing, Tenant shall pay all water, gas, electricity, telephone, sewage treatment and drainage and any other utilities or similar service charges or fees used in or on the Leased Premises. Tenant shall pay the same promptly as such charges accrue, and agrees to protect, indemnify and hold Landlord harmless from and against any and all liability for any such costs or charges. To the extent Landlord provides any such services to the Leased Premises or pays the cost for any such services, Tenant shall pay to Landlord the cost of such services as Rent hereunder upon receiving an invoice therefor pursuant to Section 5.03 hereof. ARTICLE 8. OPTION TO PURCHASE. Section 8.01. Grant of Option. For valuable consideration by Tenant to Landlord, the receipt of which is hereby acknowledged, Landlord hereby grants to Tenant the exclusive and irrevocable right and option from the Commencement Date through and during the Term of the Lease, and regardless of whether Tenant is in default hereunder, to elect to purchase the Leased Premises on the terms and conditions set forth in this Article (the "Option"). At the request of either Landlord or Tenant a Short Form Option Agreement evidencing the terms of this Article 8 shall be signed by the parties and placed of record. Section 8.02 Exercise of Option. Tenant shall exercise the Option to purchase the Leased Premises at any time, on or before the expiration of the Term of this Lease, or any extension thereof, by either: (a) delivering to Landlord written notice of such exercise, or (b) mailing such notice by registered or certified mail to Landlord at Landlord's mailing address set forth in the notice section of this Lease. In the event that the Option is not exercised on or before said date, the Option shall thereupon terminate without any further action by Landlord or Tenant including, without limitation, without notice or other release or writing required to be placed of record. Section 8.03. Purchase Price and Payments. The purchase price for the Leased Premises upon exercise of the Option shall be One Dollar ($1.00). Section 8.04. Contract for Sale. If the Option is exercised by Tenant, this instrument and the provisions herein set forth shall constitute the contract of sale between Landlord and Tenant and the same shall survive the delivery of the deed to Tenant by Landlord. Section 8.05. Title and Survey. Landlord hereby agrees to the following upon exercise of the Option by the Tenant: (a) Title to the Leased Premises to be transferred and conveyed to Tenant shall be of good record and marketable title and clear of all liens, restrictions, covenants, conditions and encumbrances (except Permitted Exceptions as hereinafter defined) and the conveyance of title to the Premises shall be by quit claim deed. (b) As evidence of Landlord's title, Tenant shall obtain at Tenant's sole cost and expense, a commitment from a title company selected by Tenant (the "Title Company") to issue to Tenant or its designee as proposed insured which shall show that Landlord's title to the premise is in the condition required by Paragraph 8.5(a) hereof, subject only to the Permitted Exceptions. (c) If the aforesaid title insurance commitment issued by the Title Company shows that title is not in the condition required by Paragraph 8.5(a) hereof, Landlord shall use reasonable efforts to remedy said defects. Landlord shall have one hundred twenty (120) days (the "Cure Period") in which to remedy the defects of title shown thereon or to obtain title insurance by the Title Company insuring over and against such defects (the premium for which, to the extent such premium exceeds the premium for a title insurance policy not insuring over and against such defects, shall be paid by Tenant) and provide evidence satisfactory to Tenant thereof. If Landlord fails to remedy such defects within such Cure Period, Tenant shall have the option, exercisable within ten (10) days from the expiration of Landlord's Cure Period, by written notice to Landlord, to (i) accept conveyance of title subject to such title defects, and proceed with the purchase of the Leased Premises (in which event said Title Commitment and the Quit Claim Deed will be accepted subject to any such defects), or (ii) to terminate this Agreement. If Tenant fails to make such written election within such ten (10) day period, Tenant shall be deemed to have elected option (i). ARTICLE 9. COMPATIBLE PARCEL. Landlord agrees that at any time during the Term of this Lease the Compatible Parcel shall be available for purchase or sublease, at the option of Tenant, by industries compatible to the Project and which are attracted to the Leased premises by reason of the Project ("Compatible Industries"). If after five (5) years after the Completion Date Compatible Industries have not purchased or subleased the Compatible Parcel and if the Landlord requires the use of the Compatible Parcel for lease or sale to another commercial business after five (5) years following the Completion Date, the Compatible Parcel shall be either severed from this Lease or, if Tenant has exercised its option to purchase the Leased Premises pursuant to Article 8, reconveyed to Landlord, upon terms and conditions, including granting by Landlord to Tenant of any necessary easements so as not to adversely affect Tenant's efficient operation of the Project, mutually agreeable to Landlord and Tenant. All costs and expenses of severing the Compatible Parcel from the Leased Premises if required for use by the Landlord shall be borne by the Landlord. All costs and expenses of severing the Compatible Parcel from the Leased Premises if required for use by a Compatible Industry shall be borne by the Tenant. If a Compatible Parcel is sold or leased to another party, all rentals or sales proceeds resulting therefrom shall belong to and be the sole property of the Landlord. ARTICLE 10. TRANSFER BY TENANT. Section 10.01. General. Tenant shall not effect or suffer any Transfer without the prior written consent of Landlord, which consent shall not be unreasonably withheld. Any attempted Transfer without such consent shall be void and of no effect. If Tenant desires to effect a Transfer, it shall deliver to Landlord written notice thereof in advance of the date on which Tenant proposes to make the Transfer, together with all of the terms of the proposed Transfer and the identity of the proposed Transferee. Landlord shall have 45 days following receipt of the notice and information within which to notify Tenant in writing whether Landlord elects (a) to refuse to consent to the Transfer and to continue this Lease in full force and effect as to the entire Leased Premises, or (b) to permit Tenant to effect the proposed Transfer. If Landlord fails to notify Tenant of its election within said 45 day period, Landlord shall be deemed to have elected option (b). The consent by Landlord to a particular Transfer shall not be deemed a consent to any other Transfer. If a Transfer occurs without the prior written consent of Landlord as provided in this Section 10.01, Landlord may nevertheless collect rent from the Transferee and apply the net amount collected to the Rent payable hereunder, but such collection and application shall not constitute a waiver of the provisions hereof or a release of Tenant from the further performance of its obligations hereunder. Notwithstanding the foregoing, Tenant may, without Landlord's consent, effect or suffer a Transfer to any person or entity in which Tenant maintains at least a 50% interest in the equity or voting rights thereof, provided that in case of such Transfer, Tenant shall not be relieved of its obligations under this Lease. Section 10.02. Conditions. The following conditions shall automatically apply to each Transfer, without the necessity of same being stated in or referred to in Landlord's written consent: (a) Tenant shall execute, have acknowledged and deliver to Landlord, and cause the Transferee to execute, have acknowledged and deliver to Landlord, an instrument in form and substance acceptable to Landlord in which (i) the Transferee adopts this Lease and assumes and agrees to perform, jointly and severally with Tenant, all of the obligations of Tenant hereunder, as to the space transferred to it, (ii) the Transferee grants Landlord an express first and prior contract lien and security interest in its improvements located upon and property brought into the transferred premises to secure its obligations to Landlord hereunder, (iii) Tenant subordinate to Landlord's statutory lien, contract lien and security interest in any liens, security interests or other rights which Tenant may claim with respect to any property of the Transferee, (iv) the Transferee agrees to use and occupy the transferred space solely for the purposes permitted under Article 4 and otherwise in strict accordance with this Lease and (v) Tenant acknowledges and agrees in writing that, notwithstanding the Transfer, Tenant remains directly and primarily liable for the performance of all the obligations of Tenant hereunder (including, without limitation, the obligation to pay all Rent), and Landlord shall be permitted to enforce this Lease against Tenant or the Transferee, or either of them, without prior demand upon or proceeding in any way against any other persons, and (b) Tenant shall deliver to Landlord a counterpart of all instruments relative to the Transfer executed by all parties to such transaction (except Landlord). ARTICLE 11. ACCESS BY LANDLORD. In accordance with procedures agreed upon in writing between Tenant and Landlord, Landlord, its employees, contractors, agents and representatives, shall have the right (and Landlord, for itself and such persons and firms, hereby reserves the right) to enter the Leased Premises at all hours (a) to inspect the Leased Premises, (b) to determine whether Tenant is performing its obligations hereunder and, if it is not, to perform same at Landlord's option and Tenant's expense, or (c) for emergency purposes, provided that Landlord shall not unreasonably or unduly interfere with Tenant's business operations. ARTICLE 12. INSURANCE. Section 12.01. Tenant's Insurance. Tenant shall obtain and maintain throughout the Term the following policies of insurance: (a) Insurance on the Project to or constituting a part of the Leased Premises (including boiler and machinery insurance, as applicable) sufficient to provide coverage for the full insurable value thereof; and the policy for such insurance shall have replacement cost endorsement or similar provisions. "Full insurable value" shall mean actual replacement value, and such full insurable value shall be confirmed from time to time (but no more frequently than the dates of renewals of such policy) at the request of Landlord by one of the insurers or (at the option of Landlord) by an insurance appraiser; (b) commercial general liability covering claims for personal injury, death and property damage occurring in or about the Leased Premises; such insurance to afford protection to the limits of $5,000,000 combined single limit each occurrence for bodily injury and property damage, subject to a $10,000,000 general aggregate limit; (c) Vehicle liability insurance, including coverage for all owned or leased vehicles; such insurance to afford protection to the limits of at least $500,000 combined single limit each accident for bodily injury and property damage; (d) Umbrella liability insurance having limits of not less than $20,000,000 [over and above the limits of liability on the underlying policies specified in clause (b) and (c) above] with respect to bodily injury or death to any number of persons in any one accident or occurrence; and (e) Worker's compensation insurance with limits required by the Workers' Compensation Laws of the Commonwealth of Pennsylvania. Tenant shall deliver to Landlord, prior to the Commencement Date, certificates of insurance described in this Article 12, or such other proof of insurance as shall be deemed acceptable by Landlord and shall, at all times during the Term, deliver to Landlord upon request true and correct copies of said insurance policies. The policies of such insurance shall (w) except for the workers' compensation insurance, name Landlord additional insured, (x) provide that it will not be cancelled or reduced in coverage without thirty (30) days' prior written notice to Landlord, (y) be primary coverage, so that any insurance coverage obtained by Landlord shall be excess thereto, and (z) permit deductible or self-insured retention limits up to a maximum of $500,000.00. Tenant shall deliver to Landlord certificates of renewal prior to the expiration date of each such policy and copies of new policies prior to terminating any such policies. Section 12.02. Waiver of Rights. Landlord and Tenant intend that all policies purchased in accordance with Section 12.01 will protect Landlord and Tenant and will provide primary coverage for all losses and damages caused by the perils covered thereby. All such policies shall contain provisions to the effect that in the event of payment of any loss or damage the insurers will have not right of recovery against any of the insureds or additional insureds thereunder. Landlord and Tenant waive all rights against each other and their respective officers, directors, employees and agents for all losses and damages caused by, arising out of or resulting from any of the perils covered by such policies. None of the above waivers shall extend to the rights that any party making such waiver may have to the proceeds of insurance held by the other as trustee or otherwise payable under any policy so issued. ARTICLE 13. INDEMNITY. Section 13.01. Tenant Indemnity. Except as provided in Section 13.02, Tenant agrees to indemnify and hold Landlord harmless from and against any and all claims, costs, expenses, actions, causes, liens, liabilities, damages, judgments and attorneys fees arising from or connected with property damage or personal injury or death caused directly or indirectly by Tenant's acts or omissions as lessee, occupant or operator of or at the Leased Premises, except any such claims, costs, expenses, actions, causes, charges, liens, liabilities, damages, judgments or attorneys fees which arise from or are connected with any property damage or personal injury or death caused by Landlord's negligent acts or omissions. Section 13.02. Landlord Indemnity. To the full extent permitted by law, Landlord hereby agrees to indemnify and hold Tenant harmless against and in respect of: (a) Any and all losses, suites, obligations, fines, damages, judgments, injuries, administrative orders, consent agreements and order, penalties, actions, causes of action, notices of potential responsibility or requests for response from government agencies, response costs, charges, costs, and expenses, including without limitation reasonable attorneys' fees and reasonable consultants' fees, claims, including but not limited to claims arising out of the release or threat of release of Hazardous Materials, loss of life, injury to persons, property, or business environmental contamination or damages to natural resources or to water supplies, whether based on tort, contract, implied or express warranty, statute, regulations, common law, or otherwise, which: (i) arises out of or is related to the presence on, remediation of, or the actual, alleged or threatened release to or from any of the Leased Premises or any Hazardous Materials caused by Landlord ; or (ii) arises out of noncompliance by Landlord with any environmental regulation relating in any way to the Leased Premises; or (iii) otherwise arises out of any environmental regulation pertaining and violated by the to Landlord and in effect on the Commencement Date relating in any way of the Leased Premises; or (b) All other actions, proceedings, demands, assessments, adjustments, costs and expenses incident to the foregoing, including, without limitation, actual attorney's fees and other out-of-pocket expenses. ARTICLE 14. CASUALTY LOSS. Section 14.01. Obligations to Restore. (a) If all or any part of the Project located on (or constituting a part of) the Leased Premises are destroyed or damaged by any casualty during the Term, Tenant may, at its option, commence and shall thereafter prosecute diligently to completion the restoration of the same to the condition in which the destroyed or damaged portion existed prior to the casualty. Tenant will perform such restoration with at least a good workmanship and quality as the improvements being restored, and in compliance with the provisions of Article 6 hereof. If all the Project is wholly destroyed by any casualty, or are so damaged or destroyed that, in Tenant's good faith judgment reasonably exercised it would be uneconomical to cause the same to be restored (and Tenant shall give written notice of such determination to Landlord within ninety (90) days after the date the casualty occurred), then Tenant shall not be obligated to restore such improvements and this Lease shall terminate as of the date of the casualty. If Landlord is required by Legal Requirements to restore the Leased Premises to its state prior to construction of the Project after any such casualty loss, Tenant shall restore the Leased Premises to such condition at its sole cost and expense. (b) If a casualty loss affecting the Leased Premises occurs, all insurance proceeds arising from policies maintained by Tenant for the damages arising from such casualty and which is attributed to the Project (including the Excluded Property) shall be distributed and paid directly to and shall be the property of Tenant. Section 14.02. Notice of Damage. Tenant shall immediately notify Landlord of any destruction of or damage to the Leased Premises. ARTICLE 15. CONDEMNATION. Section 15.01. Total Taking. If a Total Taking of the Leased Premises occurs, then this Lease shall terminate as of the date the condemning authority takes lawful possession of the Leased Premises and Tenant shall be entitled to receive and retain the Award for the Taking of the Project (including the Excluded Property) and Landlord shall be entitled to receive and retain the Award for the Taking of the balance of the Leased Premises. Section 15.02. Partial Taking. If a Partial Taking of the Leased Premises occurs, (a) this Lease shall continue in effect as to the portion of the Leased Premises not Taken, and (b) Tenant shall promptly commence and thereafter prosecute diligently to completion the restoration of the remainder of the Project located in (or constituting a part of) the Leased Premises to an economically viable unit with at least as good workmanship and quality as existed prior to the Taking. In the event of a Partial Taking of the Leased Premises, Tenant shall be entitled to receive and retain the Award for the portion of the Project Taken and the Landlord shall be entitled to receive and retain the Award for the balance of the Leased Premises. Section 15.03. Notice of Proposed Taking. Tenant and Landlord shall immediately notify the other of any Proposed Taking of any portion of the Leased Premises. Section 15.04. Option to Purchase. Nothing contained in this Article 15 shall be construed as limiting Tenant's rights to purchase the Leased Premises pursuant to Article 8 during the pendency of any proceeding for a Taking or Partial Taking of the Leased Premises and/or the Project and Landlord agrees that Tenant shall control the position of Tenant and/or Landlord during the pendency of such proceeding upon giving the Option Notice. ARTICLE 16. LANDLORD'S REPRESENTATIONS AND WARRANTIES. Section 16.01. Quiet Enjoyment. Tenant, on paying the Rent and all other sums called for herein and performing all of Tenant's other obligations contained herein, shall and may peaceably and quietly have, hold, occupy, use and enjoy the Leased Premises during the Term subject to the provisions of this lease. Landlord agrees to warrant and forever defend Tenant's right to occupancy of the Leased Premises against the claims of any and all persons whosoever lawfully claiming the same or any part thereof. Section 16.02. Warranties Pertaining to Hazardous Materials. Landlord hereby makes the following representations and warranties to Tenant pertaining to Hazardous Materials affecting the Leased Premises: (a) Except as disclosed on Schedule 16.02, no Hazardous Materials have been discharged, dispersed, released, stored, treated, generated, or allowed to escape in, on, under, or about the Leased Premises in violation of any applicable federal, state or local law, statute, ordinance, rule or regulation by the Landlord. (b) Except as disclosed on Schedule 16.02, Landlord's operations at the Leased Premises are in compliance with all applicable federal, state, and local statutes, laws, ordinances, rules and regulations related to Hazardous Materials. (c) Except as disclosed on Schedule 16.02, Landlord has not at any time received any verbal or written notice from any person, entity, or governmental body claiming a potential or actual violation by Landlord of any statute, law, ordinance, rule or regulation related to Hazardous Materials in connection with Landlord's operations at the Leased Premises. (d) Except as disclosed on Schedule 16.02, Landlord has not at any time received any verbal or written notice from any person, entity, or governmental body demanding payment or contribution from Landlord for environmental damage or injury to natural resources. (e) Except as disclosed on Schedule 16.02, Landlord is not aware of any threatened or anticipated notices or claims of the type described above in sub-paragraphs (iii) and (iv). (f) Except as disclosed on Schedule 16.02, there are not now and have not in the past been any underground storage tanks at the Leased Premises. ARTICLE 17. DEFAULTS AND REMEDIES. Section 17.01. Events of Default. Each of the following occurrences shall constitute an "Event of Default" by Tenant under this Lease: (a) The failure of Tenant to pay Rent as and when due hereunder and the continuance of such failure for a period of thirty (30) days after receipt by Tenant of written notice thereof. (b) The failure of Tenant to perform, comply with or observe any other agreement, obligation or undertaking of Tenant, or any other term, condition or provision, in this Lease, and the continuance of such failure for a period of ninety (90) days after written notice from Landlord to Tenant specifying the failure; provided that Tenant shall not be deemed to be in default if the failure cannot be reasonably cured within the ninety (90) days and Tenant commences to cure the failure within the ninety (90) days and thereafter pursues the curing of same diligently until completion; and (c) The filing of a petition by or against Tenant (i) in any bankruptcy or other insolvency proceeding, (ii) seeking any relief under the Code or any similar debtor relief law, (iii) for the appointment of a liquidator or receiver for all or substantially all of Tenant's property or for Tenant's interest in this Lease or (iv) to reorganize or modify Tenant's capital structure. Section 17.02. Remedies of Landlord. Upon any Event of Default, Landlord may, at Landlord's option and in addition to all other rights, remedies and recourses afforded Landlord hereunder or by law or equity, terminate this Lease by the giving of written notice to Tenant, in which event Tenant shall pay to Landlord upon demand the sum of (i) all Rent and other amounts accrued hereunder to the date of termination, and (ii) damages in an amount equal to the total Rent that Tenant would have been required to pay for the remainder of the Term and any costs related to the removal of the Project (if required of Landlord by Legal Requirements) and Excluded Property. Section 17.03. Landlord's Right to Pay or Perform. If Tenant fails to perform or observe any of its covenants, agreements, or obligations hereunder for a period of thirty (30) days after notice of such failure is given by Landlord, then in addition to all other rights of Landlord provided herein Landlord shall have the right, but not the obligation, at its sole election to perform or observe the covenants, agreements, or obligations which are asserted to have not been performed or observed at the expense of Tenant and to recover all costs or expenses incurred in connection therewith as Additional Rent hereunder by delivering an invoice therefor to Tenant. Any performance or observance by Landlord pursuant to this Section 17.03 shall not constitute a waiver of Tenant's failure to perform or observe. Section 17.04. Injunctive Relief; Remedies Cumulative. Landlord may restrain or enjoin any Event of Default or threatened Event of Default by Tenant hereunder without the necessity of proving the inadequacy of any legal remedy or irreparable harm. The rights, remedies and recourse of Landlord for an Event of Default shall be cumulative and no right, remedy or recourse of Landlord, whether exercised by Landlord or not, shall be deemed to be in exclusion of any other. Section 17.05. No Waiver, No Implied Surrender. Provisions of this Lease may not be waived orally or impliedly, but only by the party entitled to the benefit of the provision evidencing the waiver in writing. Thus, neither the acceptance of Rent by Landlord following an Event of Default, (whether known to Landlord or not), nor any other custom or practice followed in connection with this Lease, shall constitute a waiver by Landlord of such Event of Default or any other Event of Default. Further, the failure by Landlord to complain of any action or inaction by Tenant, or to assert that any action or inaction by Tenant constitutes (or would constitute, with the giving of notice and the passage of time) an Event of Default, regardless of how long such failure continues, shall not extinguish, waive or in any way diminish the rights, remedies and recourses of Landlord with respect to such action or inaction. No waiver by Landlord of any provision of this Lease or of any breach by Tenant of any obligation of Tenant hereunder shall be deemed to be a waiver of any other provision hereof, or of any subsequent breach by Tenant of the same or any other provision hereof. Landlord's consent to any act by Tenant requiring Landlord's consent shall not be deemed to render unnecessary the obtaining of Landlord's consent to any subsequent act of Tenant. No act or omission by Landlord (other than Landlord's execution of a document acknowledging such surrender) or Landlord's agents, including the delivery of the keys to the Leased Premises, shall constitute an acceptance of a surrender of the Leased Premises. ARTICLE 18. RIGHT OF RE-ENTRY. Upon the expiration or termination of the Term, Tenant shall immediately, quietly and peaceably surrender to Landlord possession of the Leased Premises in the condition and state of repair required under Section 6.05 hereof and Tenant shall remove the Excluded Property and the Project (if required by any Legal Requirements) in accordance with Section 6.03 hereof. If Tenant fails to surrender possession as herein required, Landlord may initiate any and all legal action as Landlord may elect to dispossess Tenant and all of its Excluded Property, and all persons or firms claiming by, through or under Tenant and all of their Excluded Property and the Project (if required by any Legal Requirements), from the Leased Premises, and may remove from the Leased Premises and store without any liability for loss, theft, damage or destruction thereto)any such Excluded Property at Tenant's sole cost and expense. For so long as Tenant remains in possession of the Leased Premises after such expiration, termination or exercise by Landlord of its re-entry right, Tenant shall be deemed to be occupying the Leased Premises as a tenant-at-sufferance, subject to all of the obligations of Tenant under this Lease. No such holding over shall extend the Term. If Tenant fails to surrender possession of the Leased Premises in the condition herein required, Landlord may, at Tenant's expense, restore the Leased Premises to such condition. ARTICLE 19. CONDITIONS PRECEDENT TO TENANT'S OBLIGATIONS. The obligations and liabilities of Tenant arising under this Lease are subject to and contingent upon the following: Section 19.01. D-L Agreement. Tenant and D-L shall have entered into the D-L Agreement upon terms and conditions reasonably acceptable to Tenant, which agreement shall contain a minimum term of 40 years, shall bind Landlord to the terms thereof and shall commit Landlord to provide rail service to the Project in accordance with the D-L Agreement either through itself, the D-L, or other entity reasonably acceptable to Tenant. Section 19.02. Permits and Approvals. Tenant shall have obtained all federal, state, county and local platting, subdivision, permits and other approvals required for construction and operation of the Project. Section 19.03. Construction Contracts. Tenant shall have executed construction, electrical, engineering and equipment supply contracts for construction and operation of the Project upon terms and conditions reasonably acceptable to Tenant. Section 19.04. Utility Service Contracts. Tenant shall have obtained electrical power, water, sewer, natural and/or propane gas and other service contracts required for operation of the Project upon terms and conditions reasonably acceptable to Tenant. Section 19.05. Engineering Tests. Tenant shall have obtained and completed all engineering tests, including soil tests, necessary for construction of the Project, the results of which shall be reasonably satisfactory to Tenant. The foregoing conditions shall be satisfied, or waived in writing by Tenant in its sole discretion, on or before December 31, 1997, or either party may, upon ten (10) days prior written notice to the other, elect to terminate this Lease. Upon such termination, neither party shall have any further rights or obligations to the other. If Landlord elects to terminate this Lease as provided in the preceding paragraph then, within such ten (10) day notice period, Tenant may waive in writing any conditions remaining unsatisfied, in which event this Lease shall remain if full force and effect. ARTICLE 20. MISCELLANEOUS. Section 20.01. Time of Essence. Time is of the essence with respect to each date or time specified in this Lease by which an event is to occur. Section 20.02. Applicable Law. This Lease shall be governed by the laws of the Commonwealth of Pennsylvania. Section 20.03. Estoppel Certificate. From time to time at the request of Landlord, Tenant will promptly and without compensation or consideration execute, have acknowledged and deliver a certificate stating (a) the rights (if any) of Tenant to extend the Term or to expand the Leased Premises, (b) the Rent (or any components of the Rent) currently payable hereunder, (c) whether this Lease has been amended in any respect and, if so, submitting copies of or otherwise identifying the amendments, (d) whether, within the knowledge of Tenant after due investigation, there are any existing breaches or defaults by Landlord hereunder and, if so, stating the defaults with reasonable particularity and (e) such other information pertaining to this Lease as Landlord may reasonably request. Section 20.04. Signs. Tenant shall be permitted to install any signs, placards or other advertising or identifying marks upon the Leased premises or upon the exterior of any improvements to or constituting a part of the Leased Premises provided that such signs have been approved in writing in advance by Landlord, which approval shall not be unreasonably withheld. Tenant agrees to remove promptly (at Tenant's sole cost and expense) upon the expiration or earlier termination of the Term any and all such signs, placards or other advertising or identifying marks. Section 20.05. Relation of the Parties. Nothing in this Lease shall be construed to make the parties partners or joint venturers or to render either party liable for any obligation of the other. Section 20.06. Notices. All notices and other communications given pursuant to this Lease shall be in writing and shall either be mailed by first class United States mail, postage prepaid, registered or certified with return receipt requested, and addressed as set forth in this Section 21.06, or delivered in person to the intended addressee, or sent by prepaid telegram, cable or telex followed by a confirmatory letter. Notice mailed in the aforesaid manner shall become effective three business days after deposit; notice given in any other manner, and any notice given to Landlord shall be effective only upon receipt by the intended addressee. For the purposes of notice, the address of (a) Landlord shall be: Lackawanna County Railroad 701 Wyoming Avenue Scranton, Pennsylvania 18509 Attn: Lawrence C. Malski, Esq. Executive Director and General Counsel and (b) Tenant shall be: Amber Milling Company, a division of Harvest States Cooperatives 1667 North Snelling Avenue P.O. Box 64594 St. Paul, Minnesota 55164 Attn: President, Amber Milling Company with a copy to: Harvest States Cooperatives 1667 North Snelling Avenue P.O. Box 64594 St. Paul, Minnesota 55164 Attn: Legal Department Each party shall have the continuing right to change its address for notice hereunder by the giving of fifteen (15) days' prior written notice to the other party in accordance with this Section 20.06; provided, however, if Tenant vacates the location that constitutes its address for notice hereunder without changing its address for notice pursuant to this Section 20.06, then Tenant's address for notice shall be deemed to be the Leased Premises. Section 20.07. Entire Agreement, Amendment and Binding Effect. This constitutes the entire agreement between Landlord and Tenant relating to the subject matter hereof and all prior agreements relative hereto which are not contained herein are terminated. This Lease may be amended only by a written document duly executed by Landlord and Tenant, and any alleged amendment which is not so documented shall not be effective as to either party. The provisions of this Lease shall be binding upon and inure to the benefit of the parties hereto and their heirs, executors, administrators, successors and assigns; provided, however, that this 21.09 shall not negate, diminish or later the restrictions on Transfers applicable to Tenant set forth elsewhere in this Lease. Section 20.08. Severability. This Lease is intended to be performed in accordance with and only to the extent permitted by all Legal Requirements. If any provision of this Lease or the application thereof to any person or circumstance shall, for any reason and to any extent, be invalid or unenforceable, but the extent of the invalidity or unenforceability does not destroy the basis of the bargain between the parties as contained herein, the remainder of this Lease and the application of such provision to other persons or circumstances shall not be affected thereby, but rather shall be enforced to the greatest extent permitted by laws. Section 20.09. Construction. Unless the contest of this Lease clearly requires otherwise, (a) pronouns, wherever used herein, and of whatever gender, shall include natural persons and corporations and associations of every kind and character; (b) the singular shall include the plural wherever and as often as may be appropriate; (c) the term "includes" or "including" shall mean "including without limitation"; (d) the word "or" has the inclusive meaning represented by the phrase "and/or"; and (e) the words "hereof" or "herein" refer to this entire Lease and not merely the Section or Article number in which such words appear. Article and Section headings in this Lease are for convenience of reference and shall not affect the construction or interpretation of this Lease. Any reference to a particular "Article" or "Section" shall be construed as referring to the indicated article or section of this Lease. Section 20.10. Recording. Landlord agrees that this Lease (including any Exhibit hereto) or a memorandum hereof may be recorded by Tenant. Section 20.11. Incorporation by Reference. Exhibits "A", "B" and "B-1" hereto are incorporated herein for any and all purposes. Section 20.12. Force Majeure. Landlord and Tenant shall be entitled to rely upon Force majeure as an excuse for timely performance hereunder only as expressly provided herein and shall not be entitled to rely upon Force Majeure as an excuse for timely performance unless the party seeking to rely on Force majeure (a) uses its good faith efforts to overcome the effects of the event of Force Majeure, (b) gives written notice to the other party within five (5) days after the occurrence of the event describing with reasonable particularity the nature thereof, (c) commences performance of its obligations hereunder immediately upon the cessation of the event and (d) give written notice to the other party within five (5) days after the cessation of the event advising the other party of the date upon which the event ceased to constitute an event of Force Majeure. Section 20.13. Interpretation. Both Landlord and Tenant and their respective legal counsel have reviewed and have participated in the preparation of this Lease. Accordingly, no presumption will apply in favor of either Landlord or Tenant in the interpretation of this Lease or in the resolution of the ambiguity of any provision hereof. Section 20.14. Multiple Counterparts. This Lease may be executed in two or more counterparts, each of which shall be an original, but all of which shall constitute but one instrument. EXECUTED as of May 30, 1997. ATTEST/SEAL: AMBER MILLING COMPANY, A DIVISION OF HARVEST STATES COOPERATIVES Nanci L. Lilja BY: /s/ Garry A. Pistoria - -------------------------------- ------------------------------ ASSISTANT SECRETARY NAME Garry A. Pistoria ----------------------------- TITLE President ---------------------------- (Affix Corporate Seal Here) LACKAWANNA COUNTY RAILROAD John M. Murgia BY: /s/ Paul R. Hart - -------------------------------- ------------------------------ ASSISTANT SECRETARY NAME Paul R. Hart ----------------------------- TITLE Chairman ---------------------------- (Affix Corporate Seal Here) EXHIBIT "A" ALL THAT CERTAIN property of the Grantor, located at Mt. Pocono, with the improvements thereon, being adjacent to Grantor's former line of railroad known as the Scranton Branch and identified as Line Code 6201 in the Recorder's Office of Monroe County in Deed Book Volume 902 at page 144, also formerly known as the Mt. Pocono Automobile Unloading Terminal, situate partly in the Townships of Pocono, Tobyhanna and Coolbaugh, County of Monroe and Commonwealth of Pennsylvania, all as indicated by "PS" on Grantor's Case Plan No. 70139, dated September 4, 1991, which is attached hereto and made a part hereof; being further described as follows: BEING all that property at said location which lies northwest of said Scranton Branch and southeast of the westerly edge of the access road located within said property. CONTAINING 41.476 acres, more or less, of land. BEING a part or portion of the same premises which Thomas F. Patton and Ralph S. Tyler, Jr., as Trustees of the Property of Erie Lackawanna Railroad Company, Debtor, by Conveyance Document No. EL-CRC-RP-62, dated March 31, 1976 and recorded on October 16, 1978, in the Recorder's Office of Monroe County, Pennsylvania, in Deed Book Volume 902 at page 139&c., granted and conveyed unto Consolidated Rail Corporation. EXCEPTING AND RESERVING, thereout and therefrom and unto the said Grantor, its lessees, successors and assigns, permanent, perpetual and assignable easements and rights in, on, under, above, over, across and through the existing access road, located on the northwesterly portion of the Premises, as a means of unimpeded and immediate ingress and egress to and from Grantor's adjoining and adjacent property, and as indicated by "ER" on the aforementioned Grantor's Case Plan No. 70139. UNDER and SUBJECT, however, to any easements or agreements of record or otherwise affecting the Premises, and to the state of facts which a personal inspection or accurate survey would disclose, and to any pipes, wires, fiber optic lines, poles, cables, culverts, drainage courses or systems and their appurtenances now existing and remaining in, on, under, over, across and through the Premises; together with the right to maintain, repair, renew, replace, use and remove same. AND One Mile of side track adjacent to the Site between mile posts 101.2 and 102.2. EXHIBIT B Excluded property: All Milling Equipment, including, but not limited to: Roller Mills, Plan and Quiver (Vibro) Sifters, Purifiers, Bran and Shorts Dusters, Flake disrupters, Spouting, Conveyance equipment (mechanical and pneumatic), Filters, Metal surge and set-off bins, feeders, vibro bin bottoms, level devices, Scales, Bucket Elevators, airlocks, Electric motors, Pin mills, Blowers (compressed air and positive pneumatics), Bin dischargers, Packaging equipment, air dryers, shelving/racking and Aspirators. All Grain Cleaning/conditioning Equipment, including, but not limited to: Magnets, Separators, flow detectors, Gravity selectors, Scourers, intermediate decanters, infestation destroyers, airlocks, automatic tempering systems, Grain tempering mixers, Conveyance equipment (mechanical and pneumatic), Filters, Fans, Bucket Elevator Monitoring system, Electric Motors, Aspirators, Blowers (compressed air and positive pneumatics), disc cylinder separators, Gravity tables, and spiral seed separators. The Removable Electrical Equipment, including, but not limited to: Motor control centers, starters, Variable speed drives, motors, Harmonic controls, Automation equipment, Programmable Logic Controllers, Computers, Scale data processors, Switch gear, electrical disconnects and I.O. racks. All spare parts and replacements, parts which are replacements for all items listed above. EX-24 4 POWER OF ATTORNEY POWER OF ATTORNEY KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature appears below hereby constitutes and appoints John D. Johnson, T. F. Baker and John Schmitz, and each of them, his or her true and lawful attorneys-in-fact and agents, each acting alone, with full power of substitution and resubstitution, for him or her and in his or her name, place and stead, in any and all capacities, to sign Form 10-K under the Securities Exchange Act of 1934, as amended, of Harvest States Cooperatives, and any and all amendments thereto, and to file the same, with all exhibits thereto and other documents in connection therewith, with the Securities and Exchange Commission, granting unto said attorneys-in-fact and agents, each acting alone, full power and authority to do and perform to all intents and purposes as he or she might or could do in person, hereby ratifying and confirming all that said attorneys-in-fact and agents, each acting alone, or the substitutes for such attorneys-in-fact and agents, may lawfully do or cause to be done by virtue hereof.
Name Title Date /s/ John D. Johnson President and Chief Executive Officer August 26, 1997 - -------------------------- (principal executive officer) John D. Johnson /s/ T. F. Baker Group Vice President - Finance August 25, 1997 - -------------------------- (principal financial officer) T. F. Baker /s/ John Schmitz Vice President - Corporate Accounting August 25, 1997 - -------------------------- (principal accounting officer) John Schmitz /s/ Steven Burnet Chairman of the Board of Directors August 22, 1997 - -------------------------- Steven Burnet /s/ Steve Carney Director August 23, 1997 - -------------------------- Steve Carney /s/ Sheldon Haaland Director August 22, 1997 - -------------------------- Sheldon Haaland /s/ Jerry C. Hasnedl Director August 22, 1997 - -------------------------- Jerry C. Hasnedl /s/ Edward Hereford Director August 22, 1997 - -------------------------- Edward Hereford /s/ Gerald Kuster Director August 22, 1997 - -------------------------- Gerald Kuster /s/ Tyrone A. Moos Director August 22, 1997 - -------------------------- Tyrone A. Moos /s/ Duane G. Risan Director August 24, 1997 - -------------------------- Duane G. Risan /s/ William J. Zarak, Jr. Director August 22, 1997 - -------------------------- William J. Zarak, Jr. /s/ Edward Ellison Director August 22, 1997 - -------------------------- Edward Ellison /s/ Leonard D. Larsen Director August 23, 1997 - -------------------------- Leonard D. Larsen /s/ Duane Stenzel Director August 22, 1997 - -------------------------- Duane Stenzel /s/ Russell W. Twedt Director August 22, 1997 - -------------------------- Russell W. Twedt /s/ Merlin Van Walleghen Director August 25, 1997 - -------------------------- Merlin Van Walleghen
EX-27 5 FINANCIAL DATA SCHEDULE
5 12-MOS MAY-31-1997 MAY-31-1997 38,064,191 0 213,501,012 10,975,000 248,373,247 579,517,494 430,450,368 206,299,403 976,705,753 467,706,447 232,458,466 0 0 0 385,099,313 976,705,753 7,024,839,260 7,109,413,861 6,967,937,476 0 63,341,552 2,859,263 19,378,833 58,756,000 6,200,000 52,556,000 0 0 0 52,556,000 0 0
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