-----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, MAL0HJCW2QQT4afqMyfJYU4HwqbVQaH6BwV/ZfIHTHoydlBkstAdVkjOV5IZ+HHs Es6efNUtQPs1W2UL+a1gSA== 0000897101-98-000889.txt : 19980828 0000897101-98-000889.hdr.sgml : 19980828 ACCESSION NUMBER: 0000897101-98-000889 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 4 CONFORMED PERIOD OF REPORT: 19980531 FILED AS OF DATE: 19980827 SROS: NONE FILER: COMPANY DATA: COMPANY CONFORMED NAME: CENEX 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: SEC FILE NUMBER: 333-17865 FILM NUMBER: 98699239 BUSINESS ADDRESS: STREET 1: 5500 CENEX DRIVE CITY: INVER GROVE HEIGHTS STATE: MN ZIP: 55077 BUSINESS PHONE: 6129469433 MAIL ADDRESS: STREET 1: 5500 CENEX DRIVE CITY: INVER GROVE HEIGHTS STATE: MN ZIP: 55077 FORMER COMPANY: FORMER CONFORMED NAME: HARVEST STATES COOPERATIVES DATE OF NAME CHANGE: 19961212 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, 1998 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM _______ TO _______. COMMISSION FILE NUMBER: 333-17865 ----------------- CENEX HARVEST STATES COOPERATIVES (Exact name of registrant as specified in its charter) MINNESOTA 41-0251095 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification Number) 5500 CENEX DRIVE (651) 451-5151 INVER GROVE HEIGHTS, MINNESOTA 55077 (Registrant's Telephone number, including (Address of principal executive office) area code) ----------------- SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT: NONE SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT: NONE ----------------- Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YES _X_ NO ___ Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K: Not applicable State the aggregate market value of the voting stock held by non-affiliates of the registrant: The registrant has no voting stock outstanding. Indicate the number of shares outstanding of each of the registrant's classes of common stock, as of the latest practicable date: The registrant has no common stock outstanding. DOCUMENTS INCORPORATED BY REFERENCE Form 8-K, dated June 10, 1998 Form S-8, dated December 12, 1997 - -------------------------------------------------------------------------------- INDEX
PAGE NO. ----- PART I. Item 1. Business The Company ............................................................. 1 Petroleum ............................................................... 2 Crop Inputs ............................................................. 3 Grain Merchandising ..................................................... 3 Oilseed Processing and Refining Defined Business Unit ................... 8 Wheat Milling Defined Business Unit ..................................... 12 Farm Marketing and Supply ............................................... 15 Feed .................................................................... 16 Services ................................................................ 17 Membership in the Company and Authorized Capital ........................ 18 Equity Participation Units .............................................. 23 Item 2. Properties .............................................................. 27 Item 3. Legal Proceedings ....................................................... 28 Item 4. Submission of Matters to a Vote of Security Holders ..................... 28 PART II. Item 5. Market for Registrant's Common Equity and Related Stockholder Matters ... 29 Item 6. Selected Financial Data Consolidated Company .................................................... 29 Oilseed Processing and Refining Defined Business Unit ................... 30 Wheat Milling Defined Business Unit ..................................... 31 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operation Consolidated Company .................................................... 32 Oilseed Processing and Refining Defined Business Unit ................... 36 Wheat Milling Defined Business Unit ..................................... 38 Item 8. Financial Statements and Supplementary Data ............................. 41 Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure ................................................... 41 PART III. Item 10. Directors and Executive Officers of the Registrant Board of Directors ...................................................... 41 Executive Officers ...................................................... 45 Item 11. Executive Compensation .................................................. 46 Item 12. Security Ownership of Certain Beneficial Owners and Management .......... 50 Item 13. Certain Relationships and Related Transactions .......................... 51 PART IV. Item 14. Exhibits, Financial Statements and Reports Filed on Form 8-K ............ 52 SUPPLEMENTAL INFORMATION ......................................................... 52 SIGNATURES ....................................................................... 53
PART I. ITEM 1. BUSINESS THE COMPANY Pursuant to a Plan of Combination dated May 29, 1998 (the "Plan of Combination"), CENEX, Inc. ("Cenex") and Harvest States Cooperatives ("Harvest States") combined through merger on June 1, 1998 (the "Combination") and Harvest States Cooperatives became the surviving corporation. In accordance with the Plan of Combination, the Articles of Incorporation and Bylaws of Harvest States Cooperatives were restated and the name of Harvest States Cooperatives was changed to "Cenex Harvest States Cooperatives". As a result of the Combination, the Company has changed its fiscal year end to August 31, and will file a Form 10-Q Transition Report under Rule 15(d)(10)(c) for the three-month period ended August 31, 1998. Each person serving as a director of Cenex or Harvest States at the time of the Combination became a director of Cenex Harvest States Cooperatives. As a result of the Combination, each holder of common stock of Cenex became a member of Cenex Harvest States Cooperatives, to the extent eligible for membership, and all equity interests of Cenex were determined and exchanged for equal equity interests in Cenex Harvest States Cooperatives at its stated dollar amount on a dollar for dollar basis as more thoroughly set forth in the Plan of Combination, a copy of which was filed as part of the Company's Form 8-K dated June 10, 1998. The Company remains an agricultural cooperative. Primary businesses of the former Cenex include both the wholesaling and retailing of petroleum products, fertilizers and chemicals, as well as the offering of agricultural services to its cooperative members. Primary businesses of the former Harvest States include grain merchandising, which involves the purchase of various grains from its Individual Members, Cooperative Association Members 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 former Harvest States operations also sells feed and other farm supplies to its Individual Members and others, offers services to its Individual Members and Cooperative Association Members, crushes and refines soybeans, mills wheat, and through a joint venture participates in the food processing and packaging business. Harvest States was the largest customer of Cenex. The Company has authorized three classes of membership: Individual Members ("Individual Members"), Cooperative Association Members ("Cooperative Association Members") 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. Cooperative Association Members are associations of producers of agricultural products complying with certain federal requirements which have conducted a minimum amount of business with the Company as prescribed by the Board of Directors during its 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 Cooperative Association Members who sell grain to the Company, and Individual Members, Defined Members and Cooperative Association Members 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 elect to add to the Capital Reserve an amount not to exceed 10% of the distributable net income from patronage income, and may also elect to 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, 1 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. PETROLEUM The petroleum operations brought to Cenex Harvest States Cooperatives by the former Cenex includes a 42,500 barrel per day refinery in Laurel, Montana, which is wholly owned by the Company, and a 74.5% ownership interest in a 75,000 barrel per day refinery in McPherson, Kansas. The Company is not in the oil exploration business but rather purchases crude oil from both domestic and foreign sources. The Laurel, Montana refinery processes primarily heavy, high sulfur Canadian oil and produces approximately 44% gasoline, 32% diesel and other distillates and 24% asphalt and other residual products. Refined fuels are shipped west on the Yellowstone Pipeline to Montana terminals and Spokane and Moses Lake, Washington; south on common carrier pipelines to Wyoming terminals and Denver, Colorado, and east on the Company's wholly owned pipeline to Glendive, Montana as well as to Minot and Fargo, North Dakota. The McPherson refinery operated by National Cooperative Refinery Association (NCRA) of which the Company owns 74.5% receives its supply of crude oil via the Jayhawk pipeline, which is wholly owned by NCRA, and through the common carrier pipelines of Osage and Kaw. The Company holds ownership interests of 35% and 33%, respectively, in these two pipelines. Approximately 81% of the crude oil processed is domestic from Kansas, Oklahoma and Texas, and 19% is Venezuelan crude. The McPherson refinery produces approximately 60% gasoline, 36% distillates and 4% propane and other products. Refined fuels are shipped via NCRA's proprietary products pipeline to its terminal in Council Bluffs, Iowa and to other markets via Kaneb and Williams common carrier pipelines. Approximately 15% of refined products are loaded to transport trucks at the refinery. The production from these two refineries is sold to the Company's member cooperatives, where the product is sold to farmers, ranchers and the general public under the Cenex brand name. Approximately 1,200 such members retail Cenex gasoline and diesel fuel. In addition to distilled fuels, the Company also wholesales other auto and farm machinery products such as oil, grease, batteries and tires, as well as providing propane for heating fuel and grain drying. The Company also operates approximately 43 convenience stores where it retails its own brand of distilled fuels along with typical convenience products. Upon the purchase of crude oil, the Company has risks of carrying the inventory, including price changes and performance risk (including delivery, quality, quantity and shipment period). To reduce the price change risk associated with holding fixed price positions, the Company generally takes opposite and offsetting positions by entering into a commodity futures contract on a regulated mercantile exchange. While hedging activities reduce the risk of loss from changing market values of crude oil and distilled products, such activities also limit the gain potential which otherwise could result from changes in market prices. 2 Because most of the Company's petroleum product market is located in rural areas, sales activity tends to follow the planting and harvest cycles. More fuel efficient equipment, reduced crop tillage, depressed prices for crops, warm winter weather, and government programs which encourage idle acres all have the effect of reducing demand for the Company's petroleum products. In addition, private petroleum companies compete with the Company. Effective September 1, 1998, the Company will form a petroleum marketing alliance with Farmland Industries, a large Kansas City, Missouri based cooperative to jointly market petroleum products in the trade areas currently served by the two companies. This alliance, Country Energy, LLC, will serve as a marketing agent for the Company and Farmland Industries, and will not own or operate the refineries. CROP INPUTS The Company, through a joint venture established by Cenex with Land O' Lakes (another regional cooperative headquartered in the St. Paul, Minnesota area) participates in the crop input business. The Company has a 50% ownership interest in the Cenex/Land O' Lakes Agronomy Company, which acts as sales agent for the two companies. The agronomy company markets plant food (fertilizers) and crop protection products (herbicides and insecticides) on behalf of its two owners. Such products are sold to the member cooperatives of the Company on a wholesale basis, as well as marketed through approximately 220 company owned facilities on a retail basis to individual farmer-patrons. The Company distributes a complete line of fertilizers, including potash, nitrogen-based fertilizers and phosphate-based fertilizers. Approximately 80% of the fertilizer products sold by the Company through its agency arrangement are purchased from CF Industries, of which the Company owns 22%. CF Industries is a large domestic fertilizer producer. The Company purchases crop protection products from several chemical companies, including Imperial, Inc., a wholly owned subsidiary of the Cenex/Land O'Lakes Agronomy Company. Many of the risk factors for the petroleum operations also apply to the agronomy product operations. Spring and fall weather conditions, depressed grain prices, idle acreage and genetic engineering of crops which are more insect and disease resistant all effect the demand for agronomy products. Competition in most of the Company's trade area for such products is also intense. Supply and price of fertilizer ingredients fluctuates widely, which exposes the Company to risk on any fixed price commitment. In addition, increased domestic and foreign production of fertilizer expands supply and tends to depress the profitability of CF Industries, of which the Company is a major equity holder. 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. Given the relatively low prices for the coming year, this activity is expected to increase, particularly in the European Union. Wheat, corn and soybean exports from the U.S. are projected to increase marginally in the crop year ending May 31, 1999. Increased net costs to Asian buyers due to negative currency fluctuations will greatly limit any further growth in exports to this region for next year. United States wheat exports are projected to decrease from 29 million metric tons (MMT) in 1998 to 28.1 MMT in 1999. The U.S. continues to face competition from Canada, Australia, Argentina and the European Union (EU). Production from these competitors is expected to increase 4 MMT for the crop year ending 3 May 31, 1999. United States corn exports are projected to increase from 36.8 MMT to 41.3 MMT in 1999. World feed grain production is expected to increase 7 MMT for crop year 1999. This increase, however, is mainly due to the increased production in the United States. United States soybean exports are projected to decrease from 24.1 MMT in 1998 to 23 MMT in 1999. Argentina and Brazil, the major competitors for U.S. exports, are projected to increase their exports 4.8 MMT due to record yields in both countries resulting in a 12.5 MMT increase in production. The Company expects that its export business will increase consistent with the increase in U.S. exports. Any substantial increase in U.S. export business will be limited by the historically strong dollar relative to other major currencies. Historical information and projections for the 1998 and 1999 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, 1998. 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 May 31, 1997 and 1998: MAY 31, MAY 31, GRAIN 1998 1997 ------------------------- ------------- ---------- Wheats .................. $ 3.89 1/2 $ 3.91 Corn .................... 2.31 1/2 2.51 Soybeans ................ 6.13 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 an increase in acreage for all oilseeds 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 Cooperative Association Members (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. Grain purchased by 4 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 Cooperative Association Members, the total grain purchased and the percentage relationship for each of the years ended May 31 are set forth below: YEARS ENDED MAY 31, ----------------------------------------------- 1998 1997 1996 ------------- ------------- ------------- Member purchases ......... 720,420,802 757,704,610 959,166,596 Total purchases .......... 1,145,851,767 1,280,557,384 1,692,438,700 Percentage ............... 62.9% 59.2% 56.7% 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, ------------------------------------------------------ 1998 1997 1996 ---------------- ---------------- ---------------- Wheat .............. 416,066,868 478,978,426 505,606,729 Corn ............... 347,494,014 425,851,278 777,631,466 Soybeans ........... 229,558,195 219,686,914 234,930,247 Barley ............. 66,085,222 61,839,145 75,225,773 Milo ............... 37,816,184 51,722,961 48,199,610 Sunflowers ......... 28,788,424 14,603,180 25,952,855 Oats ............... 9,008,016 22,487,231 20,008,442 All other .......... 11,034,844 5,388,249 4,883,578 ----------- ----------- ----------- 1,145,851,767 1,280,557,384 1,692,438,700 ============= ============= ============= Sales of grain by the Company for each of the years ended May 31 are set forth below: 1998 1997 1996 ----------------- ----------------- ----------------- Wheat .............. $1,794,441,582 $2,490,328,502 $2,631,202,689 Corn ............... 989,831,098 1,558,440,294 2,518,939,007 Soybeans ........... 1,431,966,669 1,421,789,252 1,431,485,630 All other .......... 413,313,294 565,944,576 545,596,081 -------------- -------------- -------------- Total ............. $4,629,552,643 $6,036,502,624 $7,127,223,407 ============== ============== ============== RECENT DEVELOPMENTS. For the year ended May 31, 1998: U.S. grain exports continued to slide to a four year low for wheat, soybeans and corn (89.7 million metric tons). Exports are projected to rebound modestly in 1998/99 to 93 million metric tons for the same three commodity groups. The U.S. as well as its export competitors will again produce above average crops providing large available supplies. 5 Therefore, the world grain markets will experience strong competition for limited demand into foreign markets as was the case in 1997/98. Nevertheless, the Company projects that its export handle will be similar to that of 1997/98. Historical information and projections for the 1998 and 1999 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, 1998 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 that 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 Cooperative Association Members 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. 6 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 160 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 Company has been negotiating a joint venture proposal with United Grain, Portland, Oregon, to form a grain marketing company called United Harvest, LLC. United Harvest, LLC will be a joint venture 50% owned by each company, and is projected to begin operation in September 1998. United Harvest, LLC will operate the Kalama, WA terminal elevator owned by the Company, and the Vancouver, WA terminal of United Grain as well as market the grain for each of the parent companies in the western United States, including Washington, Oregon, Idaho, Utah and Montana. 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. 7 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, 1998, the Grain Marketing Division had 435 employees, of which 74 were traders, 239 production staff, 14 management and 108 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 close to adequate sources of soybeans and strong demand for meal. Refineries are generally located next to the crushing plants. Oil is shipped throughout the United States and for export. 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. Per capita domestic consumption of soybean oil has remained fairly stable 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 8 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 acquiring other processors, expanding capacity of existing plants or building new plants, domestically or internationally. Unless exports increase or existing facilities are closed, this extra capacity is likely to put additional pressure on prices and challenge 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 margin relationships have been maintained. EQUITY PARTICIPATION UNITS At May 31, 1998 Equity Participation Units in the Oilseed Processing and Refining Defined Business Unit represented the right to deliver 1,050,000 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 within limits, 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 cash 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 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 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. 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 opened a refinery late in 1997 in Minnesota, it is no longer a 9 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 an inability to source 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, 1998. 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, 1998, 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 9% 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 that 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, 1998, the Defined Business Unit sold meal to over 500 customers, primarily feed lots and feed mills. During the year ended May 31, 1998, ten customers accounted for approximately 52% of meal sold, and two customers, which would be difficult to replace, accounted for approximately 30% of meal sold. For the year ended May 31, 1998, 56% of meal was sold in Minnesota, 28% in Wisconsin, 11% 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, 1998. COMPETITION The Company believes that the Oilseed Processing and Refining Defined Business Unit has 6 to 8% of the domestic refined soybean oil market and less than 3% of the domestic 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 10 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 that 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 currently 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. In July 1998 the Company announced its site selection for the construction of a new soybean processing and refining plant in southwestern Minnesota. The facility, to be constructed near the city of Fairmont, Minnesota, is expected to cost between $60 million and $90 million. The precise configuration and size of the crushing plant and oil refinery has yet to be determined. EMPLOYEES The Oilseed Processing and Refining Defined Business Unit currently employs 201 employees, 36 in the office in administration, sales and support service and 165 in the plant. Certain production workers are subject to collective bargaining agreements with the American Federation of Grain Millers (137 employees) expiring in 2002 and the Pipefitters' Union (2 employees) expiring in 2000. 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 that 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 $40,953,585 as of May 31, 1998. Sales by the Oilseed Processing and Refining Defined Business Unit to Ventura Foods and its predecessors in interest are shown below:
OILSEED PROCESSING AND REFINING DEFINED BUSINESS UNIT'S SALES TO HOLSUM, WILSEY & VENTURA --------------------------------------------------------- YEARS ENDED MAY 31, --------------------------------------------------------- 1998 1997 1996 ----------------- ----------------- ----------------- Sales ($) .................................. $ 101,440,009 $ 110,679,000 $ 124,299,000 Percentage of total refinery sales ......... 38% 45% 45%
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. 11 WHEAT MILLING DEFINED BUSINESS UNIT The Company's Wheat Milling Defined Business Unit mills durum wheat into flour and semolina and 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 ingredients 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 13% of the domestic market in the year ended May 31, 1998. 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, 1998. 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, 1998, Equity Participation Units in the Wheat Milling Defined Business Unit represented the right to deliver 4,739,000 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. 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 that is hedgable, 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. 12 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 include net position limits. It is defined by commodity and includes both trader and management limits. This policy 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 are 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. Additionally, the new durum futures market offers some limited potential for hedging. 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. 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 ten major customers and approximately 50 smaller customers, which are large and mid-size pasta manufacturers in the United States. The customer base is broad and diverse with no single customer being more than 11.4% of the total durum milling demand. In July 1998, American Italian Pasta Company ("AIPC") began construction of a new pasta plant adjacent to the Wheat Milling Defined Business Unit's mill in Kenosha, Wisconsin. AIPC is this country's second largest pasta manufacturer. Direct pipelines from the mill to the pasta plant will reduce costs to transfer product, creates efficiencies for both companies, as well as providing a dedicated customer/supplier relationship. Production startup for the American Italian Pasta Company plant is expected in about a year. 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 12% 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. Borden, traditionally a major customer serviced from the Rush City, MN mill, sold its two pasta plants in the Minneapolis, MN area during the year ended May 31, 1998. Although the Rush City mill 13 still provides semolina to these pasta plants, volumes have been reduced to a level at which the Defined Business Unit could service the Minneapolis, MN area customers nearly as efficiently from its Kenosha, WI mill. Consequently, the Company may elect to sell the Rush City facility, close the facility, or continue to operate at somewhat reduced volumes, depending upon the opportunities offered by the market place. 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 and has announced plans for additional milling capacity to supply its recently acquired New Hope, Minnesota plant. Philadelphia Macaroni is building a semolina mill in Minot, North Dakota. Miller Milling has recently expanded its Winchester, Virginia, semolina mill. Barilla, an Italian pasta manufacturer and durum miller, is constructing an integrated mill and pasta plant in Ames, Iowa. In the past, they have exported significant volumes of pasta from Italy into the U.S. and will now compete with domestic manufacturers in the dry retail pasta market. 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 that 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, follows:
LOCATION GRAIN MILLED CAPACITY BUSHEL EQUIVALENT - ----------------------- ------------------------- ----------------- ------------------ Rush City, MN Primarily durum 10,000 cwts/day 23,500 bu/day Huron, OH Primarily durum 9,500 cwts/day 22,800 bu/day Spring and winter wheat 5,000 cwts/day 11,000 bu/day Kenosha, WI Durum 11,000 cwts/day 26,400 bu/day Spring and winter wheat 10,000 cwts/day 22,000 bu/day Houston, TX Spring and winter wheat 13,000 cwts/day 28,600 bu/day Pocono, PA Durum 4,000 cwts/day 9,600 bu/day Spring and winter wheat 14,000 cwts/day 30,800 bu/day ----------------- ------------------ Total 76,500 cwts/day 172,700 bu/day ================= ==================
At Huron, Ohio, the land and buildings are leased from ConAgra. In June 1998, the Huron Mill began a conversion of one of the three milling units to manufacture bakery flour rather than durum semolina. This change will result in a decrease of approximately 5,000 cwts. of semolina to be converted to 5,000 cwts. of hard wheat bakery flour. 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. 14 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 began constructing semolina and flour and bread flour mills in Pocono, Pennsylvania in September 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, $15,165,000 was expended in fiscal year 1998. For the year ended May 31, 1998 the Wheat Milling Defined Business Unit facilities ran at 81% of capacity based upon a year of 307 operating days being 100%, compared to 97% in 1997. This decrease in run time was due to startup in Houston and a temporary shut down of Rush City in June and early July of 1997. EMPLOYEES As of May 31, 1998 the Wheat Milling Defined Business Unit employed the following full time equivalents: production (98), plant management (30) and headquarters (24). Of these, 23 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 160 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 50 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, 64 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 82 locations to member and non-member producers. Feed is sold at approximately 92 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:
1998 1997 1996 1995 1994 ----------------- ----------------- ----------------- -------------- -------------- No. of centers ............ 160 154 144 121 115 No. of op. units .......... 50 47 47 43 43 Grain sales (bu) .......... 214,770,000 199,922,000 214,085,000 159,891,000 141,238,000 Sales ..................... $1,072,950,000 $1,136,700,000 $1,126,600,000 $679,200,000 $613,151,000
15 As of June 1, 1998, through the merger with Cenex, the Farm Marketing and Supply Division added 92 locations which comprise 22 operating units handling primarily agronomy supplies and petroleum. 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, 1998, the Division had 879 full time employees and 404 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, 1998, 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 $50,000,000. 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 Cooperative Association Members 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:
1998 1997 1996 1995 1994 --------- --------- --------- --------- -------- Manufactured feed (tons) .......... 377,000 326,000 351,000 333,000 306,000
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 ten manufacturing facilities located in Sioux Falls, South Dakota; Great Falls, Montana; Hardin, Montana; Snohomish, Washington; 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. As of June 1, 1998 the Feed Division has entered into a joint venture with Land O' Lakes. The joint venture is named Land O' Lakes/Harvest States Feed. The joint venture includes the company owned plants in the states of Montana, North Dakota, South Dakota, Nebraska and Minnesota along with four plants owned by Land O' Lakes in the same 16 territory. The joint venture is governed by a four person board (2 from Cenex Harvest States and 2 from Land O' Lakes) and the administrative office and the general manager of the new joint venture is located in the Company's Sioux Falls, South Dakota feed administration office building. At May 31, 1998, the Division had 284 full time and 10 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 Cooperative Association Members. COUNTRY HEDGING, INC. Country Hedging, Inc. offers full service commodity futures and options brokerage. For the year ended May 31, 1998, 57% of revenues were from Cooperative Association Members, 29% from Individual Members and 14% 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, 1998, it had 38 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, 93% owned by the Company as of June 1, 1998, 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, 1998, substantially all of its revenues were from local cooperatives. Ag States Agency, LLC competes with other insurance agencies. On January 1, 1998 Ag States Agency, LLC acquired 50% ownership in Ag States Benefits, LLC. Ag States Benefits, LLC is an independent insurance agency which sells primarily group benefit policies such as health, life, dental, long term care and disability insurance to primarily local cooperative employees and members of local cooperatives. FINANCIAL SERVICES DEPARTMENT The Financial Services Department provides business planning consulting and financing to Cooperative Association Members. 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 Cooperative Association Members in the past year. During the year ended May 31, 1998, average aggregate loan balances outstanding were $49,865,070 (of which CoBank's participation was $33,520,924) and the highest aggregate loan balance outstanding at any one time was $84,050,441 (of which CoBank's participation was $48,213,799). 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". 17 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, 1998, substantially all of its revenues were from local cooperatives. FIELD SERVICES DEPARTMENT The Field Service Department acts as a liaison between Cooperative Association Members 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 Cooperative Association Members 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 receive, handle, store, warehouse, manufacture, process, market, purchase, sell and otherwise deal in the agricultural products of its members, non-member patrons and others, including without limitation, the processing and exporting of grain and other agricultural products; to manufacture, buy, sell, market, store, warehouse, acquire, transport, distribute, process, drill, mine, refine and otherwise deal in and procure for its members, non-member patrons and others, petroleum products, fuels, oil, grease, automotive parts and accessories, supplies, services, minerals, feed, seed, fertilizer, machinery, equipment, supplies, and other goods, products, and merchandise, primarily for use upon farms or by farmers, or used or useful in the business of farming, recognizing that they may also be incidentally useful to other patrons; and to engage in any other activity connected with or related to any such purposes, and to engage in any other lawful purpose. Net savings from member patronage of the Company shall be distributed to members on the basis of patronage, except that the Board of Directors may elect to add to the Capital Reserve an amount not to exceed 10% of the distributable net income from patronage business. These net savings, when distributed, are referred to as "patronage dividends," regardless of whether distributed in cash or Patron Equities. The Company may obligate itself to do business with a nonmember on a patronage basis. The determination of net savings may be made by allocation units which may be functional, divisional, departmental, geographic, or otherwise as determined by the Board of Directors, provided that each Defined Business Unit shall be accounted for as a separate allocation unit. Patronage refunds shall be distributed in cash, allocated patronage equities, revolving fund certificates, securities of this cooperative, other securities, or any combination thereof designated by the Board of Directors. 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, 1998 is 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. 18 GOVERNANCE The business and affairs of the Company are managed by a Board of Directors of not less than 17 persons (currently set at 27), 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 June, 1998. 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 restricted to associations of producers of agricultural products which are organized and operating so as to adhere to the provisions of the Agricultural Marketing Act and the Capper-Volstead Act, as amended, and to certain producers of agricultural products. The Board of Directors may establish a minimum amount of business that cooperative associations must transact with or through the Company to be eligible for membership, and also may adopt such additional conditions, qualifications, methods of acceptance, duties, rights and privileges of membership in this Company as it may from time to time deem advisable. 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 does not 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. Cooperative Associations are associations of agricultural producers. Cooperative 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 Cooperative Association Members are entitled to: (i) one vote for each producer of agricultural products registered and accepted as a member of such cooperative association who patronized the Cooperative Association within the preceding year; (ii) one vote for each $10,000 or major fraction thereof, of the average annual business transacted with the Company during the past three fiscal years; 19 and (iii) one vote for each $1,000, or major fraction thereof, of equity issued by the Company as patronage refund and standing on the books of the Company in the name of the Cooperative Association Member. 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 and Defined Members associated with a grain elevator, feed mill, seed plant or any other Company facility, except supply and marketing locations brought to the Company by Cenex, as designated and recognized by the Board of Directors. 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. Patrons' Associations are entitled to: (i) one vote for each Individual Member and Defined Member grouped in such Patrons' Association (minus one vote for each Individual Member or Defined Member in such Patrons' Association who chooses to cast a vote personally); (ii) one vote for each $10,000 or major fraction thereof, of the average annual business transacted with the Company by the Individual Members and Defined Members grouped into such Patrons' Associations, during the past three fiscal years; and (iii) one vote for each $1,000,or major fraction thereof, of equity issued by this cooperative as a patronage refund and standing on the books of this Company in the name of the Individual Members and Defined Members grouped in such Patrons' Associations, calculated on an aggregate basis. 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 were 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 that was 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. 20 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, Equity Participation Units 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 Cooperative Association Members that meet all of the requirements of membership as a Cooperative Association Member except that they do not transact at least the minimum volume 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 21 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. Beginning June 1, 1998, inactive direct members and patrons and active direct members and patrons age 61 and older on that date will continue to be eligible for patronage certificate redemption at age 72 or death. For active direct members and patrons who were age 60 or younger on June 1, 1998, and Cooperative Association Members, equities will be redeemed annually based on a prorata formula where the numerator is dollars available for such purpose as determined by the Board of Directors, and the denominator is the sum of the patronage certificates held by such eligible members and patrons. There can be no assurance that the Company's Board of Directors will not elect to modify its policy regarding the redemption of equities. 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 the Defined Business Units. DISTRIBUTION OF ASSETS UPON DISSOLUTION In the event of any dissolution, liquidation or winding up this cooperative, whether voluntary or involuntary, all debts and liabilities of this cooperative shall be paid first according to their respective priorities. As more particularly provided in the Bylaws, the remaining assets shall then be paid to the holders of equity capital to the extent of their interests therein and any excess shall be paid to the patrons of this cooperative on the basis of their past patronage. The Bylaws provide more particularly for the allocation among the members and nonmember patrons of this cooperative of the consideration received in any merger or consolidation to which this cooperative is a party. 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. 22 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 that 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 that gave the right and obligation to such person to deliver the number of bushels of soybeans equal to the number of Units purchased 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 23 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 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 24 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 during the Processing Year. Certain Cooperative Association Members 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, 25 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. 26 ITEM 2. PROPERTIES The Company owns or leases petroleum, grain handling and processing, and agronomy related facilities throughout the United States. Below is a summary of these locations. PETROLEUM Owned or leased facilities brought into the Company from the Cenex merger include the following: Refinery Laurel, Montana Propane Plants 38 locations in Iowa, Idaho, Minnesota, North Dakota, Oregon, South Dakota, Wisconsin, and Wyoming Propane Terminals 3 locations in Minnesota, North Dakota and Wisconsin Transportation Terminals/ Repair Facilities 12 locations in Iowa, Minnesota, Montana, North Dakota, South Dakota, Washington and Wisconsin, 2 of which are leased Petroleum & Asphalt Terminals/Storage Facilities 19 locations in Iowa, Kansas, Minnesota, Montana, North Dakota, Oregon, Washington and Wisconsin, 5 of which are leased Pump Stations 18 locations in Montana and North Dakota Pipelines 8 locations in Montana and North Dakota Convenience Stores/Gas Stations 43 locations in Iowa, Minnesota, Montana, Nebraska, South Dakota, Wisconsin and Wyoming Lube Plants/Warehouses 4 locations in Minnesota and Ohio
A 74.5% interest in the following facilities was also brought into the Company from the Cenex merger: Refinery McPherson, Kansas Petroleum Terminals/Storage 14 locations in Iowa, Kansas, Nebraska, Oklahoma and Texas Pipeline McPherson, Kansas to Council Bluffs, Iowa Jayhawk Pipeline Throughout Kansas, with branches in Oklahoma and Texas Jayhawk Stations 40 locations located in Kansas and Oklahoma
GRAIN 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) Winona, Minnesota(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. 27 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(2) .................... 14,500 cwts/day Kenosha, WI(1) .................. 21,000 cwts/day Houston, TX(1) .................. 13,000 cwts/day - ------------------ (1) Owned (2) Owned equipment, leased land and facilities AGRI SERVICES CENTERS The Company owned 160 Agri Service Centers (of which some of the facilities are on leased land) located in Minnesota, North Dakota, South Dakota and Montana, as of May 31, 1998. As a result of the June 1, 1998 merger with Cenex, the Company added 92 additional Agri Service Centers located in Minnesota, North Dakota, South Dakota, Montana, Washington, Oregon, Idaho, Iowa, and Colorado. 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 Snohomish, Washington 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 On or about February 3, 1998 the Company submitted to its members a vote by mail ballot on the merger with Cenex, Inc. The members voted in favor. On or about February 27, 1998, the Company submitted to its Defined Members a vote by mail ballot to (i) amend Section 13 of the resolutions creating the Defined Business Units to delete the requirement that Equity Participation Units be redeemed in connection with the unification of Harvest States Cooperatives and Cenex, Inc.; and (ii) amend the Member Marketing Agreement to: (a) change "Harvest States Cooperatives" to "Cenex Harvest States Cooperatives"; (b) change the Processing Year to match the fiscal year of Cenex Harvest States Cooperatives; and (c) allow Members the option to either deliver a pro-rata share of their bushels during any short fiscal year or roll said pro-rata share of bushels to the next full fiscal year. The Defined Members voted in favor of the amendments. 28 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, 1998, 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, 1998, 1997, 1996, 1995 and 1994. 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, -------------------------------------------------------------------------------------- 1998 1997 1996 1995 1994 ----------------- ------------------ --------------- ----------------- --------------- Income Statement Data: Revenues Sales: Grain ................................. $4,629,552,643 $6,036,502,624 $7,127,223,407 $4,191,665,535 $3,086,531,429 Processed grain ....................... 615,048,982 730,101,124 819,863,541 708,219,307 593,116,553 Feed and farm supplies ................ 262,792,836 258,235,512 207,252,696 156,699,068 165,925,459 -------------- -------------- -------------- -------------- -------------- 5,507,394,461 7,024,839,260 8,154,339,644 5,056,583,910 3,845,573,441 Patronage dividends ................... 15,534,215 15,947,049 13,278,997 6,512,481 6,609,602 Other revenues ........................ 84,520,889 68,627,552 68,339,523 57,556,984 45,895,922 -------------- -------------- -------------- -------------- -------------- 5,607,449,565 7,109,413,861 8,235,958,164 5,120,653,375 3,898,078,965 Costs and expenses: Cost of goods sold .................... 5,464,036,841 6,967,937,476 8,076,073,326 4,981,820,272 3,786,336,764 Marketing, general, and administrative ..................... 62,311,965 63,341,552 70,054,248 69,509,491 60,847,099 Interest .............................. 17,442,718 19,378,833 31,921,936 19,268,575 10,250,765 -------------- -------------- -------------- -------------- -------------- 5,543,791,524 7,050,657,861 8,178,049,510 5,070,598,338 3,857,434,628 -------------- -------------- -------------- -------------- -------------- Earnings before income taxes ............. 63,658,041 58,756,000 57,908,654 50,055,037 40,644,337 Income taxes ............................. 6,400,000 6,200,000 6,900,000 5,100,000 5,500,000 -------------- -------------- -------------- -------------- -------------- Net earnings ............................. $ 57,258,041 $ 52,556,000 $ 51,008,654 $ 44,955,037 $ 35,144,337 ============== ============== ============== ============== ============== MAY 31, -------------------------------------------------------------------------------------- 1998 1997 1996 1995 1994 --------------- --------------- --------------- --------------- --------------- Balance Sheet Data (at end of period): Working capital ......................... $ 102,454,578 $ 111,811,047 $ 95,874,938 $ 66,904,085 $ 69,409,621 Net property, plant and equipment ....... 254,475,188 224,150,965 232,145,401 205,837,690 156,311,551 Total assets ............................ 945,703,463 976,705,753 1,228,772,684 924,533,569 734,655,223 Long-term debt, including current maturities ........................... 140,610,625 134,458,466 132,629,176 84,816,525 39,135,097 Total equity ............................ 414,003,905 385,099,313 337,252,119 299,487,893 270,761,017
29 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, 1998, 1997, 1996, 1995 and 1994. 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, ------------------------------------------------------------------------------- 1998 1997 1996 1995 1994 ------------ ------------ ------------ ------------ ------------ Revenues: Processed oilseed sales ...................... $410,385,807 $441,737,923 $399,271,001 $398,095,108 $358,372,039 Other revenues and costs ..................... 1,745,743 (1,659,881) 1,435,708 1,162,518 1,349,484 ------------ ------------ ------------ ------------ ------------ 412,131,550 440,078,042 400,706,709 399,257,626 359,721,523 Costs and expenses Cost of goods sold: .......................... 379,271,678 405,791,384 371,424,566 366,407,451 334,968,474 Marketing and administrative ................. 4,729,820 4,341,904 4,544,763 5,137,663 4,722,900 Interest ..................................... 380,030 321,700 151,500 -- 164,300 ------------ ------------ ------------ ------------ ------------ 384,381,528 410,454,988 376,120,829 371,545,114 339,855,674 ------------ ------------ ------------ ------------ ------------ Earnings before income taxes .................. 27,750,022 29,623,054 24,585,880 27,712,512 19,865,849 Income taxes .................................. 1,825,000 2,100,000 1,600,000 1,500,000 1,650,000 ------------ ------------ ------------ ------------ ------------ Net earnings .................................. $ 25,925,022 $ 27,523,054 $ 22,985,880 $ 26,212,512 $ 18,215,849 ============ ============ ============ ============ ============ Operating Data: Quantities processed Soybeans (bu.) ............................. 32,625,799 32,231,520 30,446,475 30,807,933 24,136,364 Crude oil (lb.) ............................ 953,359,351 960,406,920 920,492,402 894,970,248 860,221,089 Production Meal (tons) ................................ 754,168 741,922 728,435 741,190 588,873 Flour (tons) ............................... 32,451 35,714 39,914 40,614 31,614 Refined oil (lbs.) ......................... 948,796,640 957,398,000 858,240,000 835,396,000 799,908,000 1998 1997 1996 1995 1994 ------------ ------------ ------------ ------------ ------------ Balance Sheet Data (at end of period): Working capital .............................. $ 23,110,970 $ 20,305,438 $ 28,619,585 $ 32,980,590 $ 33,813,064 Net property, plant and equipment.............. 34,952,626 33,085,560 24,771,413 20,410,408 19,577,934 Total assets ................................. 91,481,942 92,416,098 74,112,937 63,672,994 74,191,110 Long-term debt, including current maturities .................................. -- -- -- -- -- Total equity ................................. 58,063,596 53,390,998 53,390,998 53,390,998 53,390,998 Other Data(1): Pretax earnings .............................. $ 27,750,022 $ 29,623,054 $ 24,585,880 $ 27,712,512 $ 19,865,849 Earnings from purchased oil .................. (3,265,480) (7,014,758) (3,557,406) (4,680,813) (4,511,979) Non-patronage joint venture income ........... (737,836) (614,967) (1,353,708) (990,191) (1,300,427) Book to tax differences ...................... (383,719) 2,209,575 (71,485) 393,608 135,170 ------------ ------------ ------------ ------------ ------------ Tax basis soybean earnings .................... $ 23,362,987 $ 24,202,904 $ 19,603,281 $ 22,435,116 $ 14,188,613 ============ ============ ============ ============ ============ Bushels processed ............................ 32,625,799 32,231,520 30,466,475 30,807,933 22,630,472 Earnings per bushel .......................... $ 0.72 $ 0.75 $ 0.64 $ 0.73 $ 0.63
YEAR ENDED MAY 31, 1998 ------------- Equity Participation Units Outstanding ......... 1,074,000 Patronage rate ................................. $ 0.72 ----------- Earnings to holders ............................ $ 769,080 =========== - ----------------- (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. 30 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, 1998, 1997, 1996, 1995 and 1994. 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, ---------------------------------------------------------------------------------------- 1998 1997 1996 1995 1994 ----------------- ---------------- --------------- ----------------- --------------- Revenues: Sales ................................ $ 205,281,433 $199,078,687 $173,315,613 $ 119,725,183 $103,716,012 Other revenues and costs .............. 1,820,294 ------------- ------------ ------------ ------------- ------------ 207,101,727 199,078,687 173,315,613 119,725,183 103,716,012 Costs and expenses: Cost of goods sold ................... 189,614,207 181,565,899 161,293,430 112,690,679 97,206,374 Marketing and administrative ......... 8,071,913 6,749,237 4,471,563 3,834,289 2,415,155 Interest ............................. 3,121,893 5,229,669 4,457,797 2,278,544 1,832,037 Other ................................ 162,283 2,000,000 ------------- ------------ ------------ ------------- ------------ 200,970,296 195,544,805 170,222,790 118,803,512 101,453,566 Earnings before income taxes .......... 6,131,431 3,533,882 3,092,823 921,671 2,262,446 Income taxes .......................... 475,000 300,000 200,000 125,000 150,000 ------------- ------------ ------------ ------------- ------------ Net earnings .......................... $ 5,656,431 $ 3,233,882 $ 2,892,823 $ 796,671 $ 2,112,446 ============= ============ ============ ============= ============ Operating Data: Wheat used (bu.) Durum .............................. 19,306,816 21,372,000 19,376,000 16,058,000 15,763,000 Spring ............................. 8,891,000 6,732,000 3,013,000 1,638,000 1,167,000 Spring ................................ 3,164,915 Shipments (cwt) Semolina/flour ..................... 10,505,000 11,168,000 10,085,000 8,718,000 8,088,000 Baking flour ....................... 4,270,000 2,599,000 634,000 -- -- Balance Sheet Data (at end of period): Working capital ...................... $ 12,787,010 ($ 1,938,733) $ 3,338,206 $ 1,604,146 $ (4,703,152) Net property and equipment ........... 85,627,365 69,130,520 59,233,046 43,395,670 19,739,029 Total assets ......................... 146,310,885 120,918,192 125,321,564 82,606,055 55,031,562 Long-term debt, including current maturities .......................... 51,209,270 61,214,270 54,000,000 33,750,000 19,000,000 Total equity ......................... 67,957,981 27,797,072 27,797,072 27,797,072 27,797,072 Other Data(1): Pretax earnings ...................... $ 6,131,431 $ 3,533,882 $ 3,092,823 $ 921,671 $ 2,262,446 Book to tax differences .............. 689,446 2,375,920 (84,481) 123,844 (135,715) ------------- ------------ ------------ ------------- ------------ Tax basis earnings .................... $ 6,820,877 $ 5,909,802 $ 3,008,342 $ 1,045,515 $ 2,126,731 ============= ============ ============ ============= ============ Bushels milled ........................ 31,362,731 28,103,677 22,390,011 17,696,689 16,930,702 Earnings per bushel ................... $ 0.22 $ 0.21 $ 0.13 $ 0.06 $ 0.13
YEAR ENDED MAY 31, 1998 -------------- Equity Participation Units Outstanding ......... 4,787,000 Patronage rate ................................. $ 0.22 ---------- Earnings to holders ............................ $1,041,094 ========== - ----------------- (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. 31 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION CONSOLIDATED COMPANY The Year 2000 issue is the result of computer systems being written using two digits rather than four to define the applicable year. Computer programs used by the Company that have date-sensitive software may recognize a date using "00" for the year 1900 rather than as the year 2000, or vice versa. This could result in a system failure or miscalculation causing disruption of operations including an inability to process transactions or engage in similar business activities. Furthermore, should other companies or entities with whom the Company has a supplier or customer relationship encounter business disruption because of the year 2000 issue, the Company in turn could experience disruption of normal business processes and as a result incur additional costs or loss of revenue. In preparation for the Year 2000, the Company has reviewed the primary internally-developed software programs used within the divisions and defined business units comprising the Company before the June 1, 1998 merger with Cenex. Appropriate changes were made to that software to accommodate the Year 2000. In addition, the Company has engaged an information technology consulting firm for the purpose of appraising the Company's Year 2000 readiness, identifying critical software applications which are not Year 2000 compliant, remediating such applications, testing corrections to software, developing contingency plans in the event that all software problems are not corrected by the year 2000, and assisting with certifications of key supplier's Year 2000 readiness. This Year 2000 plan and action program encompasses all areas of the Company. The Company will also assess, to the extent practical, embedded technology in its processing equipment. It is expected that the assessment phase of the project will be completed by December 31, 1998, and that the remedial portion of the project will be completed by June 30, 1999. Management believes that the total cost to the Company to review and correct its own computer systems will not exceed $1 million, of which approximately $100,000 was expended through May 31, 1998. Based on its assessment, the Company's management presently believes that problems related to the Year 2000 computer issue will not have a material effect on operations and financial results. The Company will, however, incur some risk related to the Year 2000 issue if other entities not affiliated with the Company do not appropriately address their own Year 2000 compliance issues. The Company has not yet evaluated the full impact of the Year 2000 issue if third party vendors and/or customers do not resolve this issue on a timely basis. Furthermore, a contingency plan has not been completed as of this time, and will be developed after the Company, through its Year 2000 project, identifies the software applications requiring remediation. RESULTS OF OPERATIONS COMPARISON OF YEAR ENDED MAY 31, 1998 WITH 1997 The Company's consolidated net earnings of approximately $57,300,000 for the year ended May 31, 1998 represents a $4,700,000 (9%) increase from 1997. This increase is primarily attributable to improved gross margins in 1998 compared to 1997. Consolidated net sales of $5,507,000,000 in 1998 decreased $1,518,000,000 (22%). This decrease was due primarily to reduced grain prices in 1998, when the weighted average of all commodities sold declined 85 cents a bushel compared to 1997. These lower grain prices were reflected as well in the prices of the processed grain products produced and sold by the Company. In addition, grain volume declined approximately 135 million bushels in 1998. Patronage dividends received of $15,500,000 remained at about the same level as a year ago. Other revenue of $84,500,000 in 1998 increased $15,900,000 (23%). Factors contributing to this change was the expansion of various country elevator services in 1998, and losses recognized on certain properties in 1997 in the amount of approximately $4,000,000. Cost of goods sold of $5,464,000,000 decreased $1,504,000,000 (22%) in 1998 compared to 1997. This decrease is primarily attributable to lower grain prices in 1998, when the weighted average cost of all 32 commodities was $3.97 per bushel, compared to $4.84 per bushel in 1997. These comparably low grain prices also had the effect of reducing volume sold to the Company, which declined approximately 135 million bushels in 1998 compared to 1997. Marketing and administrative costs of $62,300,000 in 1998 declined approximately $1,000,000 (2%) compared to the prior year. This decrease is primarily related to the transfer of the Consumer Products Packaging Division to a nonconsolidated joint venture at the end of the first quarter of fiscal 1997, partially offset by increased costs in the Company's growth areas, specifically country elevator operations and wheat milling. Interest expense of $17,400,000 in 1998 decreased approximately $2,000,000 (10%) compared to 1997. This decrease is substantially attributable to the reduced price and volume of grain described in the discussion on cost of goods sold, which produced lower average inventory and receivable balances. Income tax expense of $6,400,000 and $6,200,000 for 1998 and 1997, respectively, results in effective tax rates of 10.1% and 10.5%. 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. 33 LIQUIDITY AND CAPITAL RESOURCES CASH FLOWS FROM OPERATIONS Operating activities of the Company provided net cash of $103,700,000 and $271,600,000 for the years ended May 31, 1998 and 1997, respectively, and used net cash of $105,700,000 for that same period ended in 1996. Net cash provided and used by operations is primarily attributable to changes in working capital requirements with such balances decreasing $48,500,000 in 1998 and $216,600,000 in 1997, thereby contributing cash, and increasing $154,200,000 in 1996, thereby using cash. CASH FLOWS FROM INVESTING For the years ended May 31, 1998, 1997, and 1996, the net cash flows used in the Company's investing activities totaled $29,300,000, $19,800,000 and $37,600,000, respectively. The acquisition of property, plant and equipment comprised the primary use of cash in each of the three years, totaling $52,300,000, $42,400,000 and $40,500,000, in 1998, 1997 and 1996, respectively. Capital expenditures for fiscal year 1999, including those for the former Cenex divisions, are expected to be approximately $185,000,000. During the year ended May 31, 1998, the Company expended $2,500,000 for convertible preferred stock of Sparta Foods, Inc., a tortilla manufacturing firm based in the Minneapolis-St. Paul area. This investment represents an 18% ownership interest in the company. These uses of cash were partially offset by proceeds from the disposition of property, plant and equipment totaling $12,800,000, $1,800,000 and $3,700,000 in 1998, 1997 and 1996, respectively. $10,300,000 of the 1998 total represents proceeds from the sale and leaseback of certain manufacturing equipment with the Oilseed Processing and Refining Defined Business Unit. Also partially offsetting cash usage were proceeds received from joint ventures and investments held in other cooperatives totaling $14,900,000, $20,600,000 and $1,800,000 in 1998, 1997 and 1996, respectively. 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 then owned by the Company as its capital investment in the 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. On May 31, 1998 the Company had short-term lines of credit totaling $525,000,000, all of which was committed, and $37,000,000 outstanding. For the years ended May 31, 1998 and 1997, the Company decreased its outstanding seasonal borrowings by $61,000,000 and $226,000,00, respectively, while for the year ended May 31, 1996, the outstanding seasonal borrowing balance increased $124,000,000. This short-term borrowing activity follows the working capital requirements created by grain volumes and prices as discussed in the "Cash flows from Operations" section of this analysis. In response to anticipated borrowing requirements after the merger with Cenex, the Company entered into a new short-term loan agreement with the banks for cooperatives and the commercial banks whereby the Company was extended a 364-day revolving credit facility of $400,000,000 and a five-year revolving facility totaling $200,000,000, all of which is committed. The Company has in the past financed its long-term capital needs, primarily for the acquisition of property, plant, and equipment, with long-term agreements through the banks for cooperatives. Total indebtedness of those agreements on May 31, 1998 and 1997 was approximately $136,000,000 and $125,000,000, respectively. The Company also had long-term debt in the form of capital leases, industrial development revenue bonds and miscellaneous notes payable totaling $4,600,000 and $9,500,000 in 1998 and 1997, respectively. 34 The Company borrowed on a long-term basis $25,000,000, $18,800,000 and $58,000,000, and repaid long-term debt in the amounts of $19,400,000, $17,400,000 and $11,300,000 in 1998, 1997 and 1996 respectively. In June 1998, the Company established a new long-term loan agreement through the banks for cooperatives whereby the term loan balance outstanding on May 31, 1998 was paid to the banks, and partially refinanced through the new agreement. The new long-term loan agreement commits $200,000,000 of long-term borrowing capacity to the Company, with repayments through the year 2009. The outstanding balance on this facility after the refinancing was $134,000,000 with $66,000,000 remaining available. Also in June 1998, as part of the refinancing program for the merged operations, the Company issued a private placement with several insurance companies for long-term debt in the amount of $225,000,000, with final payment due in the year 2013. 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 facilities and for the expansion and development of existing 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 from patronage sources were distributed to consenting patrons following the close of each fiscal year and were 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 1997, 1996 and 1995 distributed in 1998, 1997 and 1996, respectively, totaled $13,400,000, $13,200,000 and $11,000,000. Cash patronage for fiscal year 1998, deemed by the Board of Directors to be 80% for Equity Participation Units and 30% for regular patronage earnings, to be distributed in fiscal year 1999, is expected to be approximately $15,300,000 and is classified as a current liability on the May 31, 1998 balance sheet. For years ended May 31, 1998, 1997 and 1996, the Company redeemed in cash patronage certificates held by patrons who were 72 years of age and those held by estates of deceased patrons, in accordance with authorization from the Board of Directors, in the amounts of $10,100,000, $8,200,000 and $6,600,000, respectively. Beginning June 1, 1998, inactive direct members and patrons and active direct members and patrons age 61 and older on that date will continue to be eligible for patronage certificate redemption at age 72 or death. For active direct members and patrons who were age 60 or younger on June 1, 1998, and member cooperatives, equities will be redeemed annually based on a prorata formula where the numerator is dollars available for such purpose as determined by the Board of Directors, and the denominator is the sum of the patronage certificates held by such eligible members and patrons. Such redemptions related to fiscal year 1998, to be distributed in fiscal year 1999, are expected to be approximately $13,300,000 and are classified as a current liability on the May 31, 1998 balance sheet. 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' 35 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 In May, 1998 the Company announced that it had entered into discussions with Ag Processing, Inc., an oilseed processing and grain marketing cooperative headquartered in Omaha, Nebraska for the purposes of exploring the potential for an oilseed processing and refining joint venture of all or some of the respective companies' oilseed processing and refining facilities. There is no assurance that any form of joint venture will take place. 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, -------------------------------------------------------------- 1998 1997 1996 1995 1994 ---------- ---------- ---------- ---------- ---------- Gross margin percentage .............. 7.58% 7.76% 7.33% 8.25% 6.91% Marketing and administrative ......... 1.15% .98% 1.14% 1.29% 1.32% Interest ............................. .09% .07% 0.04% -- 0.05% Processing margins Crushing/bu ......................... $ .57 $ .59 $ .60 $ .59 $ .50 Refining/lb ......................... $ .0173 $ .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, 1998 WITH 1997 The Oilseed Processing and Refining Defined Business Unit's net earnings of $25,900,000 for the year ended May 31, 1998 represents a $1,600,000 decrease (6%) compared to the same period in 1997. This decrease is primarily attributable to reduced gross margins for soymeal and lower demand for refined soyoil, which reduced the Defined Business Units sales volume for refined oil. Net gains on the disposal of fixed assets of about $650,000 partially offset the decline in gross margins. Net sales of $410,400,000 for the year ended May 31, 1998 decreased by $31,300,000 (7%) compared to the same period in 1997. A reduced average sales price for processed soybean products of $201.93 per ton in 1998 compared to $241.59 per ton in 1997 was the primary contributor to the reduction in sales dollars. Other revenues of $1,700,000 for the year ended May 31, 1998 compared to 1997, increased $3,400,000. During the year ended May 31, 1997 the Defined Business Unit recognized a loss of $2,000,000 on equipment to be replaced by plant expansion and recognized a loss of $250,000 on an investment. During the current year, the Defined Business Unit recognized gains on fixed asset disposals of approximately $650,000. Cost of goods sold for the year ended May 31, 1998 of $379,300,000 decreased $26,500,000 (7%) compared to the year ended May 31, 1997. This reduction in cost is primarily attributable to a decline in the average price of soybeans during the year ended May 31, 1998, from $7.50 a bushel in 1997 to $6.80 during the current year, and to a reduction in refined oil volume, from 968 million pounds in 1997 to 953 million pounds in 1998. Interest expense for the year ended May 31, 1998 was $380,000, compared with $322,000 a year ago. Income tax expense of $1,825,000 and $2,100,000 for the years ended May 31, 1998 and 1997 respectively, results in effective tax rates of 6.6% and 7.1%. 36 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 decrease (20%) compared to the same period in 1996. This increase is primarily attributable to improved gross margins for 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 the years ended 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. 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, 1998, 1997 and 1996 provided cash of $27,200,000, $23,600,000, and $14,400,000, respectively. Net earnings of $25,900,000, $27,500,000 and $23,000,000 in 1998, 1997 and 1996, and noncash revenues and expenses of $1,400,000, $3,800,000, and $1,600,000 during each of those years, were partially offset by increased working requirements of $100,000, $7,800,000, and $10,200,000, respectively. 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, 1998, 1997 and 1996 were $3,200,000, $12,100,000, and $6,000,000, respectively. During the year ended on May 31, 1998, the Defined Business Unit expended $14,000,000 for the acquisition of property, plant and equipment and received $10,700,000 for the sale of such assets. $10,300,000 of these proceeds were part of a transaction whereby the Defined Business Unit entered into a sale and operating leaseback arrangement of certain equipment purchased and installed during fiscal 1998 and 1997. All net cash used for investing activities during the years ended May 31, 1997 and 1996 were for the acquisition of property, plant and equipment. 37 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. With respect to current year earnings, the total income from the 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. Such dividends retained as equity from Equity Participation Unit share of earnings total $153,816 and will be matched with equity on behalf of the Company's open membership in proportion to non-Equity Participation Unit bushel milled totalling $4,518,782. In July 1998 the Company announced its site selection for the construction of a new soybean processing and refining plant in southwestern Minnesota. The facility, to be constructed in the city of Fairmont, Minnesota, is expected to cost between $60 million and $90 million. The precise configuration and size of the crushing plant and oil refinery has yet to be determined. Debt outstanding and payable to the Company as of May 31, 1998 and 1997 was $22,900,000 and $25,600,000, 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 Mr. Garry A. Pistoria, the current group vice president responsible for the operations of the Wheat Milling Defined Business Unit, has announced his intention to retire as of December 31, 1998. Mr. James Tibbetts, currently group vice president responsible for the Oilseed Processing and Refining Defined Business Unit, will assume responsibility for the Wheat Milling Defined Business Unit as part of his current responsibilities for the newly created Foods Group. 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, -------------------------------------------------------------- 1998 1997 1996 1995 1994 ---------- ---------- ---------- ---------- ---------- Gross margin percentage .............. 7.63% 8.80% 6.94% 5.88% 6.28% Marketing and administrative ......... 3.93% 3.39% 2.58% 3.20% 2.33% Interest ............................. 1.52% 2.63% 2.57% 1.90% 1.80% Margins/cwt .......................... $ 1.06 $ 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, 1998 WITH 1997 The Defined Business Unit's net earnings of $5,600,000 for the year ended May 31, 1998 increased $2,400,000 (75%) compared to the same period in 1997. For the year ended May 31, 1997, the Defined Business Unit recognized a $2,000,000 loss on the impairment of fixed asset value at its Rush City, Minnesota mill. This 1997 loss represents the primary difference in net earnings between the two fiscal years. 38 Net sales for the year ended May 31, 1998 of $205,300,000 increased $6,200,000 (3%) compared to the same period ended in 1997. Increased sales volumes during the current twelve-month period contributed $19,400,000 to sales, while lower average sales prices during this same period reduced sales revenue by approximately $13,200,000. The increased sales volume was generated through expanded Kenosha operations, the commencement of operations at the Houston, Texas mill during fiscal 1998, partially offset by reduced production at the Rush City, Minnesota mill. The Defined Business Unit recognized other income during the year ended May 31, 1998 of $1,820,000. $1,450,000 of this amount represents warranty proceeds for milling equipment. Interest income of approximately $370,000 was generated during the year ended May 31, 1998 on the Defined Business Unit's working capital account with Harvest States. This interest income is primarily the result of additional capital of $38,800,000 contributed by Harvest States on June 1, 1997 for the purpose of constructing the mill at Mt. Pocono, Pennsylvania. Construction at Mt. Pocono commenced in early September 1997, and as disbursements have made for that purpose, interest-generating funds have been depleted. Cost of goods sold of $189,600,000 for the year ended May 31, 1998, increased $8,000,000 (4%) compared to the same period ended in 1997. The raw material component of cost of goods sold increased approximately $5,700,000 in 1998. The Defined Business Unit milled approximately 31.4 million bushels during the year ended May 31, 1998, an increase of approximately 3.2 million bushels over the prior year. The cost of this additional volume was partially offset by a decline of 42 cent a bushel in the average cost of raw material. The mill expense component of cost of goods sold increased approximately $2,3000,000 during the year ended May 31, 1998 compared to the prior year. This increase is primarily attributable to the commencement of operations in June at the mill in Houston, Texas, partially offset by reduced variable costs at the Rush City, Minnesota mill. As a start-up operation during fiscal 1998, the Houston mill ran at approximately 50% of capacity, which generated inadequate revenue to cover costs for that location. The Rush City mill, which was closed throughout the month of June and early July of calendar year 1997, operated at approximately two-thirds of its 1997 fiscal year production level. Marketing and administrative expenses were $8,100,000 during the year ended May 31, 1998, an increase of $1,400,000 (21%) from 1997. This increase is primarily attributable to additional staffing and system expansion costs related to the Houston mill, and in anticipation of future volumes from the Mt. Pocono mill. The Defined Business Unit incurred interest expense of $3,100,000 and $5,200,000 during the years ended May 31, 1998 and 1997, respectively. This decrease of approximately $2,100,000 (40%) during the current twelve-month period is primarily the result of the additional capital contributed by Harvest States on June 1, 1997, which decreased short-term borrowing. Other expenses were $162,283 and $2,000,000 for the years ended May 31, 1998 and 1997, respectively. During the current year, the Defined Business Unit recognized a loss on certain equipment; during 1997 the company assessed the carry value of the Rush City mill relative to expected cash flows and recognized a loss due to impairment value. Income tax expenses of $475,000 and $300,000 for the years ended May 31, 1998 and 1997, respectively, result in effective tax rates of 7.7% and 8.5%. 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. 39 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. LIQUIDITY AND CAPITAL RESOURCES The 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 cost and levels. In September 1997, the Defined Business Unit began construction of a mill at Mount Pocono, Pennsylvania. As committed in the registration statement for the original equity participation unit offering, this mill is to be financed with equity from the Company. Anticipated final cost is $41,350,000, of which approximately $15,000,000 was expended through May 31, 1998. Projected completion is for the spring of 1999. The Cenex Harvest States Board of Directors has authorized the purchase of land near Orlando, Florida as the site for a new mill. The Board has authorized between $1,350,000 and $1,755,000 for the cost of the land, depending upon whether an access road is built. Plans for this mill are subject to due diligence, routine regulatory review and cost verification. Anticipated cost for this mill is approximately $35,000,000, and may be financed with debt, open member equity, additional equity participation units, or a combination of these financing alternatives. CASH FLOWS FROM OPERATIONS Operating activities provided net cash of approximately $1,500,000 for the year ended May 31, 1998. Net earnings of approximately $5,600,000 and noncash costs and expenses of approximately $4,900,000 were partially offset by increased working capital requirements of approximately $9,000,000 for the current year. For the year ended May 31, 1997, net earnings of approximately $3,200,000, noncash costs and expenses of $6,100,000, and decreased working capital requirements of approximately $10,2000,000 all contributed to net cash provided by operating activities totaling approximately $19,600,000. Increased working capital requirements of about $22,400,000 were partially offset by net earnings of $2,900,000 and noncash expenses of $3,300,000 to use net cash of approximately $16,200,000 in operating activities for the year ended May 31, 1996. CASH FLOWS USED FOR INVESTING Net cash flows used in the Defined Business Unit's investing activities for the years ended 1998, 1997 and 1996 were approximately $20,300,000, $15,000,000 and $18,600,000, respectively. All of these amounts were for the acquisition of property, plant and equipment except for approximately $500,000 in 1996 which was related to the elimination of a minority interest effective June 1, 1994. Capital expenditures for the fifteen months ended September 1999 are expected to be approximately $32,000,000, which includes $26,000,000 for the completion of the Mount Pocono mill. 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 40 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 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 the availability of funds. Short-term debt outstanding and payable to the Company as of May 31, 1998 and 1997 was $16,800,000 and $22,400,000, respectively. These interest-bearing balances reflect working capital and fixed asset financing requirements of the respective years. On May 31, 1998 and 1997, the Defined Business Unit's long-term debt was $51,200,000 and $61,200,000, respectively. This debt, net of subsequent repayments, was incurred for the acquisition, expansion and construction of certain mills within the Defined Business Unit since 1990. On June 1, 1997, the Company contributed $38,800,000 in equity to the Defined Business Unit for the purpose of constructing the Mount Pocono mill. With respect to current year earnings, the total income from the 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. Such dividends retained as equity from Equity Participation Unit share of earnings total $208,219 and will be matched with equity on behalf of the Company's open membership in proportion to non-Equity Participation Unit bushel milled totaling $1,152,690. 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 As a result of the merger with Cenex, the Company changed accountants on June 1, 1998. A complete discussion is incorporated by reference to Form 8-K dated June 10, 1998. PART III. ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT BOARD OF DIRECTORS The table below lists the directors of the Company as of May 31, 1998, 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 had to 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, had to be less than 68 years of age at the time of election and could not be an employee of the Company or of an Affiliated Association. Each director had been an agriculture producer for the past five years. 41 DIRECTOR NAME AND ADDRESS AGE DISTRICT SINCE ------------------------------ ----- ---------- ------ Steven Burnet 57 5 1983 94699 Monkland Lane Moro, OR 97039-9705 Steve Carney 47 4 1988 P.O. Box 1122 Scobey, MT 59263-1122 Edward Ellison 62 1 1978 401 Hamburg Ave., P.O. Box 8 Herman, MN 56248-0008 Sheldon Haaland 59 1 1984 RR 2, Box 55 Hanley Falls, MN 56245-9731 Jerry Hasnedl 51 1 1995 RR 1, Box 39 St. Hilaire, MN 56754 Edward Hereford 59 5 1983 1902 Cashup Flat Road Thornton, WA 99176-9710 Gerald Kuster 63 2 1979 780 First Ave. N.E. Reynolds, ND 58275-9742 Leonard Larsen 62 2 1993 5128 - 11th Ave. N. Granville, ND 58741-9595 Tyrone Moos 60 3 1991 HCR 1, Box 1 Philip, SD 57567-9601 Duane Risan 62 2 1989 7452 - 37th Street N.W. Parshall, ND 58770-9403 Duane Stenzel 52 1 1993 RR 2, Box 173 Wells, MN 56097 Russell Twedt 48 4 1993 P.O. Box 296 Rudyard, MT 59540-0296 Merlin Van Walleghen 62 3 1993 24106 - 408th Avenue Letcher, SD 57359-6021 William Zarak 63 2 1983 3711 124th Ave. S.W. South Heart, ND 58655-9767 STEVEN BURNET. Mr. Burnet has been a director since 1983. 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 served as Secretary Treasurer through May 31, 1998. Mr. Carney operates a spring wheat and durum farm with his wife and brother. He is a former president 42 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 served as Assistant Secretary and Treasurer through May 31, 1998. 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 and served as Second Vice Chairman through May 31, 1998. 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 and served as Chairman of the Board through May 31, 1998. 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 served as Second Vice Chairman through May 31, 1998. 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 and served as First Vice Chairman through May 31, 1998. 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. 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. 43 In order to preserve continuity in governance and achieve an efficient board size, representatives of Cenex and the Company have adopted the following governance plan as part of the business combination. Cenex Harvest States will initially be governed by a 27 member Board of Directors consisting of the 14 incumbent directors of the Company and the 13 incumbent directors of Cenex, whose terms will be extended to accomplish the Plan to downsize and stagger terms described below. Until the 1999 Annual Meeting, the duties of the Chairman of the Board of Cenex Harvest States will be handled by an Office of the Chair, held by Elroy Webster and Gerald Kuster. This transition Board will serve until the annual meeting for the fiscal year ended August 31, 1999, which is expected to be held in December 1999. After the 1999 annual meeting, the combined company will be governed by a Board of Directors consisting of 17 directors, to be elected from the following regions: REGION (STATES) NUMBER OF DIRECTORS ----------------------------------------- -------------------- Region 1 (MN) 5 directors Region 2 (MT, WY) 1 director Region 3 (ND) 3 directors Region 4 (SD) 2 directors Region 5 (WI, MI, IL) 2 directors Region 6 (AK, AZ, CA, ID, OR, WA, UT) 2 directors Region 7 (IA, MO) 1 director Region 8 (CO, NE, KS, OK, TX) 1 director At the 1999 annual meeting, the Board will downsize from 27 to 17. Downsizing will be accomplished through "runoff elections" of incumbent directors, if necessary. Immediately following such downsizing, neither Cenex or the Company may have more than 10 carryover directors on the Board. The Board is also obligated to establish staggered terms so that not less than six elections will occur at the 1999 annual meeting. Approximately 1/3 of the directors will be elected at each annual meeting of members thereafter. The incumbent directors facing each other in the runoff elections and the staggered terms will be established in a fair and equitable manner prior to the 1999 elections. In all director elections, individuals must meet the following criteria to be eligible as a director candidate: (1) the candidate must be less than the age of 68, (2) the candidate must be a direct member or a member of an affiliate member, (3) the candidate must reside in the region from which he or she is to be elected, (4) the candidate must be an active farmer or rancher whose primary occupation is that of farming or ranching, and (5) the candidate must have at least one full term's experience as a director of a Cooperative Association Member. These qualifications will be reviewed by the Board of Directors of the combined company prior to the 1999 annual meeting of members. DIRECTORS' COMPENSATION The Board of Directors met monthly. Through May 31, 1998 the Company provided 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 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 As of May 31, 1998 the Board of Directors did not have any standing committees. The Board appointed 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 determined the salary and incentive compensation of the Chief Executive Officer and reviewed 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 did not have a Compensation Committee. The entire Board of Directors determined the compensation of the Chief Executive Officer and the terms of the employment agreement with the Chief Executive Officer. The Chief Executive Officer determined the compensation for all other executive officers. 44 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 as of May 31, 1998, none of whom holds any equity in the Company. Officers are elected annually by the Board of Directors.
NAME AGE POSITION ---------------------- ----- --------------------------------------------------------- John D. Johnson 50 President and Chief Executive Officer T. F. Baker 56 Group Vice President -- Finance Michael H. Bergeland 53 Group Vice President -- Grain & Agri Services Garry A. Pistoria 57 Group Vice President -- Wheat Milling James Tibbetts 49 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 21 years total experience with the Company. He currently serves on the Board of Directors of the National Council of Farmer Cooperatives (NCFC), Sparta Foods, Inc. and A. C. Toepfer Intrade Grain Companies, and is Chairman of the NCFC Agriculture, Trade and Credit Committee. Mr. Johnson also serves on the Management Committee for Ventura Foods, LLC. Mr. Johnson graduated in 1970 from Black Hills State University at Spearfish, South Dakota, with a degree in Business Administration and Economics. 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 45 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. As of June 1, 1998, Noel Estenson, who was the President and Chief Executive Officer of Cenex, became the Chief Executive Officer of Cenex Harvest States to serve through no later than December 31, 2000. John D. Johnson, who was the President and Chief Executive Officer of the Company, will become the President and General Manager of Cenex Harvest States, reporting to the Chief Executive Officer. Mr. Johnson will assume the position of Chief Executive Officer of Cenex Harvest States upon Mr. Estenson's retirement. 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, 1998, exceeded $100,000 (the "Named Executive Officers") (The titles of these officers have changed since the merger on June 1, 1998): SUMMARY COMPENSATION TABLE
ANNUAL COMPENSATION ------------------------ YEAR ENDED OTHER ANNUAL ALL OTHER MAY 31, SALARY(1) BONUS(1) COMPENSATION(2) COMPENSATION(3) ------------ ----------- ---------- ----------------- ---------------- John D. Johnson 1998 $550,000 350,000 $ 6,699 $11,600 President and Chief Executive Officer Thomas F. Baker 1998 244,200 147,000 10,271 13,735 Group Vice President -- Finance Michael H. Bergeland 1998 233,100 140,000 6,099 10,352 Group Vice President -- Grain and Agri-Services Garry A. Pistoria 1998 190,200 114,000 1,473 11,341 Group Vice President -- Wheat Milling James Tibbetts 1998 180,000 108,000 2,489 5,266 Group Vice President -- Oilseed Processing and Refining Division - ------------------
(1) Amounts shown include amounts deferred at the employee's election under the Company's Deferred Compensation Program and amounts waived for share options. (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. 46 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. THE FOLLOWING SUMMARIZES CERTAIN BENEFITS IN EFFECT AS OF 5/31/98 TO THE NAMED EXECUTIVE OFFICERS. DUE TO THE MERGER WITH CENEX, IT IS EXPECTED THAT THERE WILL BE CHANGES TO THESE BENEFIT PLANS, WITH MOST CHANGES OCCURRING ON JANUARY 1, 1999. 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, 1998. 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, 1998. 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, 1998, 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: 47 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, 1997, the dollar value of the account of each of the Named Executive Officers was: John D. Johnson ..................... $193,012 Thomas F. Baker ..................... 238,952 Michael H. Bergeland ................ 415,030 Garry A. Pistoria ................... 483,650 James Tibbetts ...................... 7,983 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. 48 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. In October 1997, the Company adopted a share option plan, which allows executive officers to waive bonuses and up to a certain percent of salary in exchange for options to purchase at a discount, shares of mutual funds. The Company has filed a Form S-8, dated December 12, 1997 on this program, incorporated herewith by reference. 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 or waived under the Share Option 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, 1997, the dollar value of the account of each of the Named Executive Officers will be approximately: John D. Johnson ....................... $ 196,642 Thomas F. Baker ....................... 105,867 Michael H. Bergeland .................. 618,274 Garry A. Pistoria ..................... 1,345,932 James Tibbetts ........................ 14,202 49 ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT Beneficial ownership of equity securities as of May 31, 1998, is shown below:
AMOUNT AND NATURE OF BENEFICIAL TITLE OF 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% =============== ====
AMOUNT AND NATURE OF BENEFICIAL TITLE OF CLASS NAME OF BENEFICIAL OWNER(1) OWNERSHIP % OF CLASS - ----------------------- -------------------------------- -------------- ----------- 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%. 50 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, 1998, 1997 and 1996 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 1998 1997 1996 ------------------------------ ----------- ---------- ----------- William Zarak ................ $102,422 $ 55,644 $303,125 Russell Twedt ................ 54,236 101,031 121,257 Steve Carney ................. 449,564 250,641 746,263 Tyrone Moos .................. 149,860 172,527 Jerry Hasnedl ................ 341,744 143,369 Merlin Van Walleghen ......... 100,147 148,275 Edward Ellison ............... 79,060 Leonard Larsen ............... 122,056 51 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.
PAGE NO. --------- I. HARVEST STATES COOPERATIVES Report of Independent Accountants ..................................................... F-1 Consolidated Balance Sheets as of May 31, 1998 and 1997 ............................... F-2 Consolidated Statements of Earnings for the Years Ended May 31, 1998, 1997, and 1996 .............................................................................. F-3 Consolidated Statements of Capital for the Years Ended May 31, 1998, 1997, and 1996 .............................................................................. F-4 Consolidated Statements of Cash Flows for the Years Ended May 31, 1998, 1997, and 1996 .............................................................................. F-5 Notes to Consolidated Financial Statements for the Years Ended May 31, 1998, 1997, and 1996 .................................................................................. F-6 II. OILSEED PROCESSING AND REFINING DEFINED BUSINESS UNIT Report of Independent Accountants ..................................................... F-16 Balance Sheets as of May 31, 1998 and 1997 ............................................ F-17 Statements of Earnings for the Years Ended May 31, 1998, 1997, and 1996 ............... F-18 Statements of Defined Business Unit Equity for the Years Ended May 31, 1998, 1997, and 1996 .............................................................................. F-19 Statements of Cash Flows for the Years Ended May 31, 1998, 1997, and 1996 ............. F-20 Notes to Financial Statements for the Years Ended May 31, 1998, 1997, and 1996 ........ F-21 III. WHEAT MILLING DEFINED BUSINESS UNIT Report of Independent Accountants ..................................................... F-27 Balance Sheets as of May 31, 1998 and 1997 ............................................ F-28 Statements of Earnings for the Years Ended May 31, 1998, 1997, and 1996 ............... F-29 Statements of Defined Business Unit Equity for the Years Ended May 31, 1998, 1997, and 1996 .............................................................................. F-30 Statements of Cash Flows for the Years Ended May 31, 1998, 1997, and 1996 ............. F-31 Notes to Financial Statements for the Years Ended May 31, 1998, 1997, and 1996 ........ F-32
(a)(2) FINANCIAL STATEMENT SCHEDULES None. (a)(3) EXHIBITS 10.17 Operating Agreement of Land O' Lakes/Harvest States, L.L.C. dated May 30, 1998 between Harvest States Cooperatives and Land O' Lakes, Inc. 24 Power of Attorney. 27 Financial Data Schedule. (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, 1998. (c) EXHIBITS The exhibits shown in Item 14(a)(3) above are being filed herewith. (d) SCHEDULES None. SUPPLEMENTAL INFORMATION As a cooperative, the Company does not utilize proxy statements. 52 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 27, 1998. CENEX HARVEST STATES COOPERATIVES By: /S/ JOHN D. JOHNSON ------------------------------------ John D. Johnson PRESIDENT AND GENERAL MANAGER 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 27, 1998: SIGNATURE TITLE --------- ----- /s/ JOHN D. JOHNSON President and General Manager - ------------------- (principal executive officer) John D. Johnson /s/ T. F. BAKER Executive Vice President -- Finance and - ------------------- Administration (principal financial officer) T. F. Baker /s/ JOHN SCHMITZ Vice President -- Finance and Information - ------------------- Services (principal accounting officer) John Schmitz Gerald Kuster* Chairman of the Board of Directors (as of May 31, 1998) Steven Burnet* Director Steve Carney* Director Sheldon Haaland* Director Jerry C. Hasnedl* Director Edward Hereford* 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 53 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, 1998 and 1997 and the related consolidated statements of earnings, capital, and cash flows for each of the three years in the period ended May 31, 1998. 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, 1998 and 1997 and the results of its operations and its cash flows for each of the three years in the period ended May 31, 1998, in conformity with generally accepted accounting principles. As discussed in Note 16 to the financial statements, effective June 1, 1998, the Company merged with CENEX, Inc. to form Cenex Harvest States Cooperatives. Deloitte & Touche, LLP Minneapolis, MN July 24, 1998 F-1 HARVEST STATES COOPERATIVES AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS MAY 31, 1998 AND 1997
1998 1997 -------------- -------------- ASSETS CURRENT ASSETS: Cash .................................................. $ 33,635,720 $ 38,064,191 Receivables (Note 2) .................................. 231,093,679 267,517,690 Inventories (Note 3) .................................. 210,895,285 248,373,247 Prepaid expenses and deposits ......................... 25,032,017 25,562,366 ------------ ------------ Total current assets ................................ 500,656,701 579,517,494 OTHER ASSETS: Investments (Note 4) .................................. 142,079,754 126,547,616 Other (Note 5) ........................................ 48,491,820 46,489,678 ------------ ------------ Total other assets .................................. 190,571,574 173,037,294 PROPERTY, PLANT, AND EQUIPMENT (Notes 6 and 7) ......... 254,475,188 224,150,965 ------------ ------------ $945,703,463 $976,705,753 ============ ============ LIABILITIES AND CAPITAL CURRENT LIABILITIES: Notes payable (Note 7) ................................ $ 37,000,000 $ 98,000,000 Patron credit balances ................................ 36,933,087 25,190,513 Advances received on grain sales ...................... 87,637,756 125,071,207 Drafts outstanding .................................... 33,568,876 32,698,943 Accounts payable and accrued expenses ................. 155,100,637 152,451,010 Patronage dividends and retirements payable ........... 28,629,000 13,200,000 Current portion of long-term debt (Note 7) ............ 19,332,767 21,094,774 ------------ ------------ Total current liabilities ........................... 398,202,123 467,706,447 LONG-TERM DEBT (Note 7) ................................ 121,277,858 113,363,692 OTHER LIABILITIES ...................................... 12,219,577 10,536,301 COMMITMENTS AND CONTINGENCIES (Notes 8 and 13) CAPITAL (Note 8) ....................................... 414,003,905 385,099,313 ------------ ------------ $945,703,463 $976,705,753 ============ ============
See notes to consolidated financial statements. F-2 HARVEST STATES COOPERATIVES AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF EARNINGS YEARS ENDED MAY 31, 1998, 1997, AND 1996
1998 1997 1996 ----------------- ----------------- ----------------- REVENUES: Sales: Grain ........................................ $4,629,552,643 $6,036,502,624 $7,127,223,407 Processed grain .............................. 615,048,982 730,101,124 819,863,541 Feed and farm supplies ....................... 262,792,836 258,235,512 207,252,696 -------------- -------------- -------------- 5,507,394,461 7,024,839,260 8,154,339,644 Patronage dividends ............................ 15,534,215 15,947,049 13,278,997 Other revenues (Note 12) ....................... 84,520,889 68,627,552 68,339,523 -------------- -------------- -------------- 5,607,449,565 7,109,413,861 8,235,958,164 COSTS AND EXPENSES: Cost of goods sold ............................. 5,464,036,841 6,967,937,476 8,076,073,326 Marketing, general, and administrative ......... 62,311,965 63,341,552 70,054,248 Interest ....................................... 17,442,718 19,378,833 31,921,936 -------------- -------------- -------------- 5,543,791,524 7,050,657,861 8,178,049,510 -------------- -------------- -------------- EARNINGS BEFORE INCOME TAXES .................... 63,658,041 58,756,000 57,908,654 INCOME TAXES (Note 11) .......................... 6,400,000 6,200,000 6,900,000 -------------- -------------- -------------- NET EARNINGS .................................... $ 57,258,041 $ 52,556,000 $ 51,008,654 ============== ============== ============== DISTRIBUTION OF NET EARNINGS: Cash to patrons ................................ $ 15,300,000 $ 13,200,000 $ 13,220,462 Patronage certificates ......................... 32,478,313 30,800,000 30,877,406 Nonpatronage certificates ...................... 8,609,383 7,885,168 6,115,487 Capital reserve ................................ 870,345 670,832 795,299 -------------- -------------- -------------- Net earnings ................................ $ 57,258,041 $ 52,556,000 $ 51,008,654 ============== ============== ==============
See notes to consolidated financial statements. F-3 HARVEST STATES COOPERATIVES AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CAPITAL
PATRONAGE NONPATRONAGE TOTAL CERTIFICATES CERTIFICATES --------------- ---------------- -------------- BALANCE AT MAY 31, 1995: Stated as capital ...................... $ 299,487,893 $ 215,765,522 $ 1,832,136 Stated as current liability ............ 11,000,000 ------------- ------------- ----------- 310,487,893 215,765,522 1,832,136 Distribution of patronage dividends payable for preceding year, including cash payment of $10,992,918 ........................... (10,992,918) 25,617,898 7,912,297 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 Net earnings ........................... 51,008,654 Patronage dividends payable in cash, stated as a current liability ......... (13,100,000) ------------- ------------- ----------- BALANCE AT MAY 31, 1996: Stated as capital ...................... 337,252,119 241,516,152 9,739,995 Stated as current liability ............ 13,100,000 ------------- ------------- ----------- 350,352,119 241,516,152 9,739,995 Distribution of patronage dividends payable for preceding year, including cash payment of $13,220,462 ........................... (13,220,462) 30,877,406 6,115,487 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) Net earnings ........................... 52,556,000 Initial investment offering ............ 10,836,690 (2,035,171) Patronage dividends payable in cash, stated as a current liability ......... (13,200,000) ------------- ------------- ----------- BALANCE AT MAY 31, 1997: Stated as capital ...................... 385,099,313 267,384,011 15,144,440 Stated as current liability ............ 13,200,000 ------------- ------------- ----------- 398,299,313 267,384,011 15,144,440 Distribution of patronage dividends payable for preceding year, including cash payment of $13,389,017 ........................... (13,389,017) 31,257,996 6,862,964 Redemption of capital equity certificates .......................... (10,062,587) (9,542,215) (520,372) Equities issued ........................ 10,560,902 10,560,902 Other .................................. (33,747) 127,898 (178,409) Net earnings ........................... 57,258,041 8,609,383 Patronage dividends payable in cash, stated as a current liability ......... (15,300,000) Retirements payable in cash, stated as a current liability ................ (13,329,000) (13,329,000) ------------- ------------- ----------- BALANCE AT MAY 31, 1998 ................. $ 414,003,905 $ 286,459,592 $29,918,006 ============= ============= =========== OILSEED WHEAT PROCESSING MILLING & REFINING PATRONAGE CAPITAL EPUs EPUs PAYABLE RESERVE ------------- -------------- ---------------- -------------- BALANCE AT MAY 31, 1995: Stated as capital ...................... $ 25,700,000 $ 56,190,235 Stated as current liability ............ 11,000,000 -------------- ------------ 36,700,000 56,190,235 Distribution of patronage dividends payable for preceding year, including cash payment of $10,992,918 ........................... (36,700,000) (7,823,113) Redemption of capital equity certificates .......................... Equities issued ........................ Other .................................. (279,804) Net earnings ........................... 43,700,000 7,308,654 Patronage dividends payable in cash, stated as a current liability ......... (13,100,000) -------------- ------------ BALANCE AT MAY 31, 1996: Stated as capital ...................... 30,600,000 55,395,972 Stated as current liability ............ 13,100,000 -------------- ------------ 43,700,000 55,395,972 Distribution of patronage dividends payable for preceding year, including cash payment of $13,220,462 ........................... (43,700,000) (6,513,355) Redemption of capital equity certificates .......................... Equities issued ........................ Other .................................. 1,460,384 Net earnings ........................... 44,000,000 8,556,000 Initial investment offering ............ $9,574,000 $4,296,000 (998,139) Patronage dividends payable in cash, stated as a current liability ......... (13,200,000) ---------- ---------- -------------- ------------ BALANCE AT MAY 31, 1997: Stated as capital ...................... 9,574,000 4,296,000 30,800,000 57,900,862 Stated as current liability ............ 13,200,000 ---------- ---------- -------------- ------------ 9,574,000 4,296,000 44,000,000 57,900,862 Distribution of patronage dividends payable for preceding year, including cash payment of $13,389,017 ........................... (44,000,000) (7,509,977) Redemption of capital equity certificates .......................... Equities issued ........................ Other .................................. (96,000) (96,000) 208,764 Net earnings ........................... 47,778,313 870,345 Patronage dividends payable in cash, stated as a current liability ......... (15,300,000) Retirements payable in cash, stated as a current liability ................ ---------- ---------- -------------- ------------ BALANCE AT MAY 31, 1998 ................. $9,478,000 $4,200,000 $ 32,478,313 $ 51,469,994 ========== ========== ============== ============
See notes to consolidated financial statements. F-4 HARVEST STATES COOPERATIVES AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS YEARS ENDED MAY 31, 1998, 1997, AND 1996
1998 1997 1996 ---------------- ---------------- ---------------- CASH FLOWS FROM OPERATING ACTIVITIES: Net earnings ........................................... $ 57,258,041 $ 52,556,000 $ 51,008,654 Adjustments to reconcile net earnings to net cash flows: Depreciation and amortization ........................ 21,560,587 20,450,050 20,421,425 Noncash gain on investment ........................... (12,131,232) (11,598,013) (12,517,993) Noncash portion of patronage dividends received (10,440,761) (11,050,057) (9,607,657) (Gain) loss on sale of property, plant, and equipment .......................................... (1,040,902) 4,612,341 (853,024) Change in assets and liabilities: Receivables ......................................... 36,524,214 99,499,286 (33,013,948) Inventories ......................................... 37,477,962 186,133,871 (186,968,498) Patron credit balances .............................. 11,742,574 (3,816,906) (30,483,224) Advances received on grain sales .................... (37,433,451) (76,753,983) 78,403,202 Accounts payable, accrued expenses, and drafts outstanding ................................. 3,519,560 (2,123,030) 43,477,378 Prepaid expenses, deposits, and other ............... (3,312,010) 13,693,059 (25,590,317) ------------- -------------- -------------- Total adjustments .................................. 46,466,541 219,046,618 (156,732,656) ------------- -------------- -------------- Net cash provided by (used in) operating activities ........................................ 103,724,582 271,602,618 (105,724,002) CASH FLOWS FROM INVESTING ACTIVITIES: Proceeds from disposition of property, plant, and equipment ............................................. 12,830,798 1,763,543 3,729,810 Investments redeemed ................................... 14,920,636 14,863,786 2,518,863 Acquisition of property, plant, and equipment .......... (52,323,604) (42,372,618) (40,501,980) Payments on notes receivable ........................... 339,290 632,526 398,851 Investments ............................................ (3,050,100) (1,274,069) Investments in joint ventures .......................... (35,000) 5,736,097 (727,266) Other .................................................. (1,993,999) (437,941) (1,778,678) ------------- -------------- -------------- Net cash used in investing activities .............. (29,311,979) (19,814,607) (37,634,469) CASH FLOWS FROM FINANCING ACTIVITIES: Net (payments) borrowings under line of credit agreements ............................................ (61,000,000) (226,000,000) 124,000,000 Long-term debt borrowings .............................. 25,000,000 18,795,000 57,961,058 Principal payments on long-term debt ................... (14,458,874) (16,094,879) (10,546,075) Principal payments under capital lease obligations ..... (4,930,596) (1,262,305) (739,884) Redemption of capital equity certificates .............. (10,062,587) (8,204,091) (6,554,160) Proceeds from sale of equity participation units, net of expenses ....................................... 10,836,690 Cash patronage dividends paid .......................... (13,389,017) (13,220,462) (10,992,918) ------------- -------------- -------------- Net cash (used in) provided by financing activities ........................................ (78,841,074) (235,150,047) 153,128,021 ------------- -------------- -------------- (DECREASE) INCREASE IN CASH ............................. (4,428,471) 16,637,964 9,769,550 CASH AT BEGINNING OF YEAR ............................... 38,064,191 21,426,227 11,656,677 ------------- -------------- -------------- CASH AT END OF YEAR ..................................... $ 33,635,720 $ 38,064,191 $ 21,426,227 ============= ============== ==============
See notes to consolidated financial statements. F-5 HARVEST STATES COOPERATIVES AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED MAY 31, 1998, 1997, AND 1996 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, 1998, 1997, and 1996 were as follows:
1998 1997 1996 ---------------- ---------------- ---------------- Africa ................. $ 280,000,000 $ 227,000,000 $ 195,000,000 Asia ................... 1,217,000,000 2,318,000,000 2,150,000,000 Europe ................. 404,000,000 577,000,000 465,000,000 North America .......... 331,000,000 360,000,000 205,000,000 South America .......... 268,000,000 18,000,000 85,000,000
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. F-6 HARVEST STATES COOPERATIVES AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) YEARS ENDED MAY 31, 1998, 1997, AND 1996 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) 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. NEW ACCOUNTING STANDARDS -- In June 1997, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS) No. 131, Disclosures about Segments of an Enterprise and Related Information, which relates to financial reporting of operating or business segments of a company. The new standard is effective for fiscal years beginning after December 15, 1997. Management is currently evaluating this new standard and has not yet determined its applicability or impact on the presentation of the Company's financial statements. In June 1998, FASB issued SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities, which relates to the accounting for derivative transactions and hedging activities. This new standard is effective for years beginning after June 15, 1999. While management does not believe this standard will materially impact the financial results of the Company, it is currently evaluating the reporting requirements under this new standard. 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 Receivables as of May 31:
1998 1997 --------------- --------------- Trade .............................. $ 207,689,447 $ 213,501,012 Elevator accounts .................. 23,478,016 56,172,256 Other .............................. 11,911,216 8,819,422 ------------- ------------- 243,078,679 278,492,690 Less allowance for losses .......... (11,985,000) (10,975,000) ------------- ------------- $ 231,093,679 $ 267,517,690 ============= =============
3. INVENTORIES Inventories as of May 31:
1998 1997 --------------- --------------- Grain and oilseed ............................. $138,838,640 $176,605,333 Processed grain and oilseed products .......... 37,543,688 35,139,534 Feed and farm supplies ........................ 34,512,957 36,628,380 ------------ ------------ $210,895,285 $248,373,247 ============ ============
F-7 HARVEST STATES COOPERATIVES AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) YEARS ENDED MAY 31, 1998, 1997, AND 1996 4. INVESTMENTS Investments as of May 31:
1998 1997 --------------- --------------- Cooperatives: St. Paul Bank for Cooperatives .................... $ 9,495,183 $ 8,666,195 National Bank for Cooperatives .................... 3,998,435 3,546,889 Cenex, Inc. ....................................... 22,095,630 16,391,560 Central Ferry Terminal Association ................ 1,190,000 1,222,415 Pro Fac Cooperative ............................... 1,810,256 1,789,706 Land O' Lakes, Inc. ............................... 11,810,240 7,692,077 Ag Processing, Inc. ............................... 19,410,569 16,614,505 Intrade Corporation ............................... 1,167,266 1,869,073 Farmland Industries ............................... 1,321,564 1,220,261 Lewis-Clark Terminal, Inc. ........................ 1,248,027 1,208,339 Joint Ventures: Tacoma Export Marketing Company ................... 7,147,499 9,163,887 Ventura Foods, L.L.C. ............................. 40,953,585 40,505,480 Harvest States -- Farmland Specialty Feed ......... 1,166,135 854,678 Ag States Agency, L.L.C. .......................... 5,071,273 5,018,293 Farmland-Harvest States, L.L.C. ................... 909,100 1,092,660 Archer Daniels Midland Common Stock ................. 6,177,924 6,213,860 Sparta Foods ........................................ 2,500,000 International Malting Company ....................... 700,000 700,000 Other ............................................... 3,907,068 2,777,738 ------------ ------------ $142,079,754 $126,547,616 ============ ============
5. OTHER ASSETS Other assets as of May 31:
1998 1997 -------------- -------------- Leasehold rights and other intangibles, less accumulated amortization of $8,189,990 and $6,824,986 ............. $14,332,674 $15,232,601 Notes receivable ....................................... 1,081,018 1,520,511 Prepaid expenses and other assets ...................... 33,078,128 29,736,566 ----------- ----------- $48,491,820 $46,489,678 =========== ===========
F-8 HARVEST STATES COOPERATIVES AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) YEARS ENDED MAY 31, 1998, 1997, AND 1996 6. PROPERTY, PLANT AND EQUIPMENT Property, plant, and equipment as of May 31:
ESTIMATED USEFUL LIFE IN YEARS 1998 1997 ------------ ----------------- ----------------- Grain terminals and country elevators ......... 3 to 50 $ 249,368,203 $ 229,171,093 Grain processing plants ....................... 3 to 40 187,315,494 163,918,161 Feed plants ................................... 3 to 40 27,060,403 24,706,884 Corporate office facilities ................... 3 to 40 13,286,965 12,654,230 -------------- -------------- 477,031,065 430,450,368 Less accumulated depreciation ................. (222,555,877) (206,299,403) -------------- -------------- $ 254,475,188 $ 224,150,965 ============== ==============
During the years ended May 31, 1998, 1997, and 1996, the Company capitalized interest of $338,700, $588,731, and $739,101, respectively. 7. BORROWINGS NOTES PAYABLE: The Company has a seasonal loan agreement of $123,000,000 committed with St. Paul Bank for Cooperatives, $3,500,000 and $9,000,000 of which were outstanding on May 31, 1998 and 1997, respectively. The Company has a seasonal loan agreement of $277,000,000 committed with National Bank for Cooperatives, $3,500,000 and $44,000,000 of which were outstanding on May 31, 1998 and 1997, respectively. The Company also has seasonal loan agreements of $125,000,000 committed with commercial banks ($150,000,000 at May 31, 1997), $30,000,000 and $45,000,000 of which were outstanding on May 31, 1998 and 1997, respectively. The average weighted interest rates as of May 31, 1998 and 1997 were 5.77% and 5.80%, respectively. Major financial covenants of these 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, 1998 was $488,000,000. F-9 HARVEST STATES COOPERATIVES AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) YEARS ENDED MAY 31, 1998, 1997, AND 1996 7. BORROWINGS (CONTINUED) LONG-TERM DEBT AT MAY 31:
1998 1997 ---------------- ---------------- St. Paul Bank for Cooperatives, with fixed and variable interest rates from 6.41% to 8.75%, due in installments through 2007 ............................................. $ 72,262,833 $ 68,550,333 National Bank for Cooperatives, with fixed and variable interest rates from 6.41% to 8.50%, due in installments through 2007 ............................................. 63,770,833 56,458,333 Industrial Development Revenue Bonds, payable through July 2004, interest rate of 7.4% ......................... 1,850,000 2,100,000 Capitalized lease obligations with fixed and variable rates, 8.0% at May 31, 1998 ..................................... 621,197 5,551,793 Mortgages payable and other ................................ 2,105,762 1,798,007 ------------- ------------- 140,610,625 134,458,466 Less current portion ....................................... (19,332,767) (21,094,774) ------------- ------------- $ 121,277,858 $ 113,363,692 ============= =============
See Note 16 for changes to long-term borrowings effective June 1, 1998. 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. 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. Subscribers were allowed to purchase a portion of their EPUs by exchanging existing patronage certificates. 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 ending 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 EPUs 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, and it is the Board's goal to retire such equity on a revolving basis seven years after declaration. See Note 16 for changes to the Company's patronage policy effective June 1, 1998. F-10 HARVEST STATES COOPERATIVES AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) YEARS ENDED MAY 31, 1998, 1997, AND 1996 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. Net pension expense for the years ended May 31 consists of the following:
1998 1997 1996 ---------------- --------------- --------------- Service cost -- benefits earned during the period .......... $ 2,475,111 $ 2,883,242 $ 2,496,711 Interest cost on projected benefit obligation .............. 5,802,681 5,907,204 5,587,377 Actual return on plan assets ............................... (14,400,220) (2,441,078) (6,860,278) Net amortization and deferral .............................. 8,170,903 (4,081,960) 555,130 ------------- ------------ ------------ $ 2,048,475 $ 2,267,408 $ 1,778,940 ============= ============ ============
The funded status of the plans and the amount recognized on the consolidated balance sheets as of May 31 are as follows:
1998 1997 -------------- -------------- Actuarial present value of benefit obligations: Accumulated benefit obligation, including vested benefits of $84,901,955 and $75,515,800, respectively ........................ $ 89,428,668 $ 77,644,611 ============ ============ Projected benefit obligation for service rendered to date ......... $ 94,075,077 $ 78,660,275 Plan assets at fair value .......................................... 86,888,669 76,348,832 ------------ ------------ Plan assets less than projected benefit obligation ................. (7,186,408) (2,311,443) Unrecognized net loss .............................................. 33,879,357 27,737,539 Unrecognized transition gain at June 1, 1985 recognized over 13 years ..................................................... (1,259,030) Unrecognized prior-service cost .................................... (1,282,266) (1,330,578) Additional minimum liability ....................................... (864,612) (837,742) ------------ ------------ Prepaid pension cost ............................................... $ 24,546,071 $ 21,998,746 ============ ============
The determination of the actuarial present value of the projected benefit obligation was based on a weighted average discount rate of 7.00% in 1998, and 7.75% in 1997 and 1996, and a rate of increase in future compensation of 5% in 1998, 1997, and 1996. The expected long-term rate of return on plan assets was 8.5% in 1998 and 1997, and 8% in 1996. 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. F-11 HARVEST STATES COOPERATIVES AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) YEARS ENDED MAY 31, 1998, 1997, AND 1996 10. POSTRETIREMENT MEDICAL AND OTHER BENEFITS (CONTINUED) The accrued postretirement medical and other benefits costs which are not funded were as follows at May 31:
1998 1997 --------------- --------------- Accumulated postretirement benefit obligation (APBO): Retirees ...................................................... $ 4,469,542 $ 4,371,635 Fully eligible active plan participants ....................... 1,290,572 775,433 Other active plan participants ................................ 4,500,895 3,032,288 ------------ ------------ Total APBO ................................................... 10,261,009 8,179,356 Unrecognized transition obligation ............................. (7,970,082) (8,501,474) Unrecognized net gains ......................................... 1,850,292 3,526,263 ------------ ------------ Accrued postretirement medical and other benefits cost ......... $ 4,141,219 $ 3,204,145 ============ ============
The components of the net periodic cost are as follows:
1998 1997 1996 ------------- ------------- ------------- Service cost -- benefits earned during the year .......... $ 474,502 $ 320,925 $ 337,182 Interest cost on projected benefit obligation ............ 658,729 594,742 548,997 Amortization of unrecognized gains ....................... (102,810) (147,241) (228,025) Amortization of transition obligation .................... 531,392 531,392 554,710 Curtailment cost ......................................... 205,947 ---------- ---------- ---------- Net periodic postretirement cost ......................... $1,561,813 $1,505,765 $1,212,864 ========== ========== ==========
The calculations assumed a discount rate of 7.00% in 1998 and 7.75% in 1997 and 1996 and a health-care-cost trend rate of 9.00% in 1998, declining to 6.00% in 2004. If the health-care-cost trend rate increased by 1.00%, the APBO would increase by 7.30% and the service cost and interest cost components would increase by 9.90%. 11. PROVISION FOR INCOME TAXES The provision for income taxes for each of the three years ended May 31 was as follows:
1998 1997 1996 ------------- ------------- ------------- Current provision ........................ $6,300,000 $6,200,000 $7,100,000 Deferred -- principally federal .......... 100,000 (200,000) ---------- ---------- ---------- Total provision .......................... $6,400,000 $6,200,000 $6,900,000 ========== ========== ==========
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:
1998 1997 1996 ---------- ---------- ---------- Statutory federal income tax rate ...................................... 35.0% 35.0% 35.0% State and local income taxes, net of federal income tax benefit ........ 5.0 4.9 4.3 Patronage earnings ..................................................... (30.0) (29.8) (29.6) Other .................................................................. .5 2.2 ----- ----- ----- Effective rate ......................................................... 10.0% 10.6% 11.9% ===== ===== =====
F-12 HARVEST STATES COOPERATIVES AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) YEARS ENDED MAY 31, 1998, 1997, AND 1996 12. OTHER REVENUES
YEARS ENDED MAY 31, ----------------------------------------------- 1998 1997 1996 ------------- --------------- ------------- Storage and handling ...................... $ 9,260,012 $ 7,424,823 $ 8,722,537 Service revenues .......................... 31,897,431 27,419,350 20,572,679 Commissions ............................... 6,886,616 5,879,621 6,837,272 Joint venture income ...................... 12,131,233 11,598,013 12,517,993 Gain (loss) on sale of property, plant, and equipment ................................ 1,040,903 (4,612,341) 853,024 Interest income ........................... 9,449,895 9,448,433 11,581,221 Other ..................................... 13,854,799 11,469,653 7,254,797 ----------- ------------ ----------- $84,520,889 $ 68,627,552 $68,339,523 =========== ============ ===========
13. COMMITMENTS AND CONTINGENCIES At May 31, 1998 and 1997, the Company stored grain and processed grain products for others totaling $69,000,000 and $61,200,000, 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 $27,000,000, of which $7,700,000 was outstanding as of May 31, 1998. All outstanding loans are current with respective creditors as of May 31, 1998. The Company leases approximately 3,500 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 are as follows:
RAIL CARS VEHICLES OTHER TOTAL ------------- ------------- -------------- ------------- Years ending August 31: Three months ending August 31, 1998 ............ $ 4,850,251 $ 1,414,936 $ 593,717 $ 6,858,904 1999 ........................ 17,113,709 5,552,907 3,621,460 26,288,076 2000 ........................ 11,631,412 4,411,889 3,167,012 19,210,313 2001 ........................ 7,694,315 3,156,696 2,860,200 13,711,211 2002 ........................ 5,446,817 1,864,238 2,595,524 9,906,579 2003 ........................ 4,028,270 839,761 2,433,682 7,301,713 2004 and thereafter ......... 2,381,915 336,902 9,452,679 12,171,496 ----------- ----------- ----------- ----------- $53,146,689 $17,577,329 $24,724,274 $95,448,292 =========== =========== =========== ===========
Total rent expense, net of rail car mileage credits received from the railroad and subleases, was approximately $15,199,000, $13,624,000, and $12,454,000 for the years ended May 31, 1998, 1997, and 1996, respectively. Mileage credits and sublease income were approximately $14,175,000, $13,641,000, and $7,257,000 for the years ended May 31, 1998, 1997, and 1996, 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. F-13 HARVEST STATES COOPERATIVES AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) YEARS ENDED MAY 31, 1998, 1997, AND 1996 14. SUPPLEMENTAL CASH FLOW STATEMENT INFORMATION Additional information concerning supplemental disclosures of cash flow activities for the years ended May 31 is as follows:
1998 1997 1996 -------------- -------------- -------------- Net cash paid during year for: Interest ............................................... $17,879,119 $20,737,222 $31,836,722 Income taxes ........................................... 4,808,699 4,457,322 3,934,688 Significant noncash transactions: Noncash patronage refunds issued from prior year's earnings ....................................... 31,257,996 30,877,406 25,617,898 Noncash nonpatronage certificates issued from prior year's earnings ................................. 6,862,964 6,115,487 7,912,297 Capital equity certificates issued in exchange for elevator properties ................................... 10,560,902 4,985,585 8,721,542 Capital equity certificates exchanged for EPUs ......... 2,035,171
15. FAIR VALUE OF FINANCIAL INSTRUMENTS SFAS 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. 16. SUBSEQUENT EVENTS Effective June 1, 1998, the Company merged with CENEX, Inc. (Cenex) to form Cenex Harvest States Cooperatives (CHS). All outstanding allocated equities of the two merging companies will be exchanged for equity in Cenex Harvest States Cooperatives with a stated value equal to the amount exchanged. Summarized financial information of Cenex as of May 31, 1998 is as follows:
MAY 31, 1998 ----------------- Total assets ................. $1,620,420,163 Total liabilities ............ 953,837,823 Equities ..................... 666,582,340
YEAR ENDED MAY 31, 1998 ----------------- Revenues ..................... $2,725,605,331 Net income ................... 98,387,443
In response to anticipated borrowing requirements after the merger with Cenex, the Company replaced its existing short-term debt facility with a new short-term loan agreement with the banks for cooperatives and the commercial banks whereby the Company was extended a 364-day revolving credit facility of $400,000,000 and a five-year revolving facility totaling $200,000,000, all of which is committed. The Company also repaid its existing debt to the St. Paul Bank for Cooperatives and the National Bank for Cooperatives and established a new long-term loan agreement through the same institutions whereby the term loan balance outstanding on May 31, 1998 was paid to the banks, and partially refinanced through the new agreement. The new long-term loan agreement commits $200,000,000 of long-term borrowing capacity to the Company, with repayments through the year 2009. The outstanding balance on this facility after the refinancing was $134,000,000 with $66,000,000 remaining available. F-14 HARVEST STATES COOPERATIVES AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) YEARS ENDED MAY 31, 1998, 1997, AND 1996 16. SUBSEQUENT EVENTS (CONTINUED) Also in June 1998, as part of the refinancing program for the merged operations, the Company issued a private placement with several insurance companies for long-term debt in the amount of $225,000,000, with final payment due in the year 2013. Annual maturities of outstanding long-term indebtedness of CHS due in years ending after May 31, 1998 are as follows: 1999 .......................... $ 443,566 2000 .......................... 5,101,327 2001 .......................... 7,202,277 2002 .......................... 7,449,557 2003 .......................... 7,730,027 2004 and thereafter ........... 354,172,114
Beginning June 1, 1998, inactive direct members and patrons and active direct members and patrons age 61 and older on that date will continue to be eligible for patronage certificate redemption at age 72 or death. For active direct members and patrons who were age 60 or younger on June 1, 1998, and member cooperatives, equities will be redeemed annually based on a pro rata formula where the numerator is dollars available for such purpose as determined by the Board of Directors, and the denominator is the sum of the patronage certificates held by such eligible members and patrons. Such redemptions related to fiscal year 1998, to be distributed in fiscal year 1999, are expected to be approximately $13,300,000 and are classified as a current liability on the May 31, 1998 balance sheet. F-15 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, 1998 and 1997 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, 1998. 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 audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, such financial statements present fairly, in all material respects, the financial position of the Oilseed Processing and Refining Defined Business Unit at May 31, 1998 and 1997 and the results of its operations and its cash flows for each of the three years in the period ended May 31, 1998, in conformity with generally accepted accounting principles. Deloitte & Touche, LLP Minneapolis, MN July 24, 1998 F-16 OILSEED PROCESSING AND REFINING DEFINED BUSINESS UNIT (A DEFINED BUSINESS UNIT OF HARVEST STATES COOPERATIVES) BALANCE SHEETS MAY 31, 1998 AND 1997
1998 1997 -------------- -------------- ASSETS CURRENT ASSETS: Receivables (Note 2) ................................ $32,585,292 $34,169,676 Inventories (Note 3) ................................ 23,758,625 22,850,699 Prepaid expenses and deposits ....................... 185,399 2,310,163 ----------- ----------- Total current assets .............................. 56,529,316 59,330,538 PROPERTY, PLANT, AND EQUIPMENT (Note 4) .............. 34,952,626 33,085,560 ----------- ----------- $91,481,942 $92,416,098 =========== =========== LIABILITIES AND DEFINED BUSINESS UNIT EQUITY CURRENT LIABILITIES: Due to Harvest States Cooperatives (Note 5) ......... $22,890,878 $25,584,178 Accounts payable and accrued expenses ............... 10,527,468 13,440,922 ----------- ----------- Total current liabilities ......................... 33,418,346 39,025,100 COMMITMENTS AND CONTINGENCIES (Note 10) DEFINED BUSINESS UNIT EQUITY (Note 6) ................ 58,063,596 53,390,998 ----------- ----------- $91,481,942 $92,416,098 =========== ===========
See notes to financial statements. F-17 OILSEED PROCESSING AND REFINING DEFINED BUSINESS UNIT (A DEFINED BUSINESS UNIT OF HARVEST STATES COOPERATIVES) STATEMENTS OF EARNINGS YEARS ENDED MAY 31, 1998, 1997, AND 1996
1998 1997 1996 --------------- --------------- --------------- REVENUES: Processed oilseed sales ........................ $410,385,807 $441,737,923 $399,271,001 Other revenue (expense) ........................ 1,745,743 (1,659,881) 1,435,708 ------------ ------------ ------------ 412,131,550 440,078,042 400,706,709 COSTS AND EXPENSES: Cost of goods sold ............................. 379,271,678 405,791,384 371,424,566 Marketing, general, and administrative ......... 4,729,820 4,341,904 4,544,763 Interest ....................................... 380,030 321,700 151,500 ------------ ------------ ------------ 384,381,528 410,454,988 376,120,829 ------------ ------------ ------------ EARNINGS BEFORE INCOME TAXES .................... 27,750,022 29,623,054 24,585,880 INCOME TAXES (Note 9) ........................... 1,825,000 2,100,000 1,600,000 ------------ ------------ ------------ NET EARNINGS .................................... $ 25,925,022 $ 27,523,054 $ 22,985,880 ============ ============ ============
See notes to financial statements. F-18 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, 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 Divisional equity distributed .................... (27,523,054) ------------- BALANCE AT MAY 31, 1997 ........................... 53,390,998 Net earnings ..................................... 25,925,022 Defined business unit equity distributed ......... (21,252,424) ------------- BALANCE AT MAY 31, 1998 ........................... $ 58,063,596 =============
See notes to financial statements. F-19 OILSEED PROCESSING AND REFINING DEFINED BUSINESS UNIT (A DEFINED BUSINESS UNIT OF HARVEST STATES COOPERATIVES) STATEMENTS OF CASH FLOWS YEARS ENDED MAY 31, 1998, 1997, AND 1996
1998 1997 1996 ---------------- ---------------- ---------------- CASH FLOWS FROM OPERATING ACTIVITIES: Net earnings ........................................... $ 25,925,022 $ 27,523,054 $ 22,985,880 Adjustments to reconcile net earnings to net cash provided by operating activities: Depreciation and amortization ........................ 2,021,430 1,777,475 1,598,965 (Gain) loss on sale of property, plant, and equipment ........................................... (658,290) 2,045,150 31,765 Changes in assets and liabilities: Receivables ......................................... 1,584,384 (11,374,064) (2,407,691) Inventories ......................................... (907,926) 3,384,521 (8,980,005) Prepaid expenses and deposits ....................... 2,124,764 (1,999,471) 213,459 Accounts payable and accrued expenses ............... (2,913,454) 2,201,334 957,592 ------------- ------------- ------------- Total adjustments ................................. 1,250,908 (3,965,055) (8,585,915) ------------- ------------- ------------- Net cash provided by operating activities ......... 27,175,930 23,557,999 14,399,965 CASH FLOWS FROM INVESTING ACTIVITIES: Proceeds from disposition of property, plant, and equipment ............................................. 10,722,956 Acquisition of property, plant, and equipment .......... (13,953,162) (12,136,772) (5,991,735) ------------- ------------- ------------- Net cash used in investing activities ............. (3,230,206) (12,136,772) (5,991,735) CASH FLOWS FROM FINANCING ACTIVITIES: Net (repayments to) borrowings from Harvest States Cooperatives ................................... (2,693,300) 16,101,827 14,577,650 Defined business unit equity distributed ............... (21,252,424) (27,523,054) (22,985,880) ------------- ------------- ------------- Net cash used in financing activities ............. (23,945,724) (11,421,227) (8,408,230) ------------- ------------- ------------- INCREASE IN CASH ........................................ CASH AT BEGINNING OF YEAR ............................... ------------- ------------- ------------- CASH AT END OF YEAR ..................................... $ -- $ -- $ -- ============= ============= =============
See notes to financial statements. F-20 OILSEED PROCESSING AND REFINING DEFINED BUSINESS UNIT (A DEFINED BUSINESS UNIT OF HARVEST STATES COOPERATIVES) NOTES TO FINANCIAL STATEMENTS YEAR ENDED MAY 31, 1998, 1997, AND 1996 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. 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. REVENUE FROM SIGNIFICANT CUSTOMERS -- Sales to two customers accounted for 25% and 10% of total sales for the year ended May 31, 1998, and 25% and 11% of total sales for the year ended May 31, 1997. Sales to one customer accounted for 31% of total sales for the year ended May 31, 1996. F-21 OILSEED PROCESSING AND REFINING DEFINED BUSINESS UNIT (A DEFINED BUSINESS UNIT OF HARVEST STATES COOPERATIVES) NOTES TO FINANCIAL STATEMENTS (CONTINUED) YEARS ENDED MAY 31, 1998, 1997, AND 1996 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) NEW ACCOUNTING STANDARDS -- In June 1997, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS) No. 131, DISCLOSURES ABOUT SEGMENTS OF AN ENTERPRISE AND RELATED INFORMATION, which relates to financial reporting of operating or business segments of a company. The new standard is effective for fiscal years beginning after December 15, 1997. Management is currently evaluating this new standard and has not yet determined its applicability or impact on the presentation of the Company's financial statements. In June 1998, FASB issued SFAS No. 133, ACCOUNTING FOR DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES, which relates to the accounting for derivative transactions and hedging activities. This new standard is effective for years beginning after June 15, 1999. While management does not believe this standard will materially impact the financial results of the Company, it is currently evaluating the reporting requirements under this new standard. 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, ------------------------------- 1998 1997 -------------- -------------- Trade ............................. $32,980,292 $34,564,676 Less allowance for losses ......... (395,000) (395,000) ----------- ----------- $32,585,292 $34,169,676 =========== ===========
3. INVENTORIES
MAY 31, ------------------------------ 1998 1997 ------------- -------------- Oilseed ............................ $ 6,925,703 $11,740,227 Processed oilseed products ......... 16,832,922 11,110,472 ----------- ----------- $23,758,625 $22,850,699 =========== ===========
F-22 OILSEED PROCESSING AND REFINING DEFINED BUSINESS UNIT (A DEFINED BUSINESS UNIT OF HARVEST STATES COOPERATIVES) NOTES TO FINANCIAL STATEMENTS (CONTINUED) YEARS ENDED MAY 31, 1998, 1997, AND 1996 4. PROPERTY, PLANT, AND EQUIPMENT
ESTIMATED MAY 31, USEFUL LIFE -------------------------------------- IN YEARS 1998 1997 ------------ ---------------- ---------------- Land ............................................ $ 762,829 $ 630,043 Elevators, crushing plant, and refinery ......... 15 to 20 22,103,417 21,262,318 Machinery and equipment ......................... 5 to 18 51,564,691 46,235,522 Furniture and fixtures .......................... 3 to 12 379,363 379,363 Other ........................................... 5 to 12 103,238 99,112 ------------- ------------- 74,913,538 68,606,358 Less accumulated depreciation ................... (44,392,138) (42,576,795) ------------- ------------- 30,521,400 26,029,563 Construction-in-progress ........................ 4,431,226 7,055,997 ------------- ------------- $ 34,952,626 $ 33,085,560 ============= =============
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 year ended May 31, 1996, 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 years ended May 31, 1998 and 1997, respectively, the Company charged 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, 1998, 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 borrowings, if needed, could be obtained at the Company's long-term borrowing rate. 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 persons engaged in the production of agricultural products or associations of producers of agricultural products. Qualified subscribers have the right and obligation to deliver annually the number of bushels of soybeans equal to the number of Units held. Qualified subscribers 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 F-23 OILSEED PROCESSING AND REFINING DEFINED BUSINESS UNIT (A DEFINED BUSINESS UNIT OF HARVEST STATES COOPERATIVES) NOTES TO FINANCIAL STATEMENTS (CONTINUED) YEARS ENDED MAY 31, 1998, 1997, AND 1996 7. RETIREMENT PLANS (CONTINUED) 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, 1998, 1997, and 1996 were approximately $120,000, $147,000, and $169,000, 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:
1998 1997 -------------- -------------- Accumulated benefit obligation, including vested benefits of $84,901,955 and $75,515,800, respectively $89,428,668 $77,644,611 Projected benefit obligation for service rendered to date ................................................ 94,075,077 78,660,275 Plan assets at fair value ............................ 86,888,669 76,348,832
The determination of the actuarial present value of the projected benefit obligation was based on a weighted average discount rate of 7.0% in 1998 and 7.75% in 1997 and 1996, and a rate of increase in future compensation of 5% in 1998, 1997, and 1996. The expected long-term rate of return on plan assets was 8.5% in 1998 and 1997, and 8% in 1996. 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:
1998 1997 --------------- --------------- Accumulated postretirement benefit obligation (APBO): Retirees ........................................ $ 4,469,542 $ 4,371,635 Fully eligible active plan participants ......... 1,290,572 775,433 Other active plan participants .................. 4,500,895 3,032,288 ------------ ------------ Total APBO ..................................... 10,261,009 8,179,356 Unrecognized transition obligation ............... (7,970,082) (8,501,474) Unrecognized net gains ........................... 1,850,292 3,526,263 ------------ ------------ Accrued postretirement medical and other benefits costs .................................. $ 4,141,219 $ 3,204,145 ============ ============
The net periodic costs billed to the Defined Business Unit for the years ended May 31, 1998, 1997, and 1996 were approximately $246,000, $229,000, and $197,000, respectively. The calculations assumed a discount rate of 7.00% in 1998 and 7.75% in 1997 and 1996 and a health care cost trend rate of 9.00% in 1998, declining to 6.00% in 2004. If the health care cost trend rate increased by 1.00%, the APBO would increase by 7.30% and the service cost and interest cost components would increase by 9.90%. F-24 OILSEED PROCESSING AND REFINING DEFINED BUSINESS UNIT (A DEFINED BUSINESS UNIT OF HARVEST STATES COOPERATIVES) NOTES TO FINANCIAL STATEMENTS (CONTINUED) YEARS ENDED MAY 31, 1998, 1997, AND 1996 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. The Defined Business Unit has no significant deferred income tax assets or liabilities. A reconciliation of the statutory federal tax rate to the effective rate for the years ended May 31 were as follows:
1998 1997 1996 ---------- ---------- ---------- Statutory federal income tax rate ................. 35.0% 35.0% 35.0% State and local income taxes, net of federal income tax benefit ...................................... 5.0 4.9 4.3 Patronage earnings ................................ (32.7) (32.6) (35.0) Other ............................................. ( .7) ( .2) 2.2 ----- ----- ----- Effective rate .................................... 6.6% 7.1% 6.5% ===== ===== =====
10. COMMITMENTS AND CONTINGENCIES Leases for approximately 353 rail cars with remaining lease terms of one to fifteen years are used by the Defined Business Unit. Minimum rental payments due under these operating leases at May 31, 1998 are as follows: Year ending May 31: 1999 .................................. $1,705,740 2000 .................................. 1,174,000 2001 .................................. 1,000,205 2002 .................................. 859,800 2003 .................................. 706,440 2004 and thereafter ................... 317,520 ---------- $5,763,705 ==========
Total rent expense, net of rail car mileage credits received from the railroad and subleases, was $1,887,118, $1,944,747, and $1,832,413 for the years ended May 31, 1998, 1997, and 1996, respectively. In September 1997, the Defined Business Unit (the Lessee) entered into a sales leaseback agreement. After 111 months, the Lessee has the option to: (i) purchase the equipment at fair market value; (ii) continue the lease; or (iii) return the equipment to the Lessor and pay a maximum termination fee of $718,680 contingent upon the Lessor's inability to recover the full value of the equipment, as determined from the casualty loss value schedule in the lease agreement. After 120 months, the Lessee has the option to: (i) purchase the equipment at fair market value, limited to 10% of the net equipment cost at lease inception; (ii) renew the lease for a period of 36 months; or (iii) return the equipment to the Lessor. F-25 OILSEED PROCESSING AND REFINING DEFINED BUSINESS UNIT (A DEFINED BUSINESS UNIT OF HARVEST STATES COOPERATIVES) NOTES TO FINANCIAL STATEMENTS (CONTINUED) YEARS ENDED MAY 31, 1998, 1997, AND 1996 10. COMMITMENTS AND CONTINGENCIES (CONTINUED) Minimum rental payments due under the operating lease at May 31, 1998 are as follows: Year ending May 31: 1999 .................................. $ 1,239,655 2000 .................................. 1,239,655 2001 .................................. 1,239,655 2002 .................................. 1,239,655 2003 .................................. 1,309,290 2004 and thereafter ................... 6,033,917 ----------- $12,301,827 ===========
Total rent expense related to the sales leaseback was $829,880 for the year ended May 31, 1998. 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, 1998, the operations of the Defined Business Unit had outstanding oilseed purchase contracts of 748,435 bushels at prices ranging from $6.92 per bushel to $7.37 per bushel, and outstanding oil purchase contracts of 181,712,763 pounds at prices ranging from $0.2585 per pound to $0.2803 per pound. In addition, the operations of the Defined Business Unit had outstanding sales contracts totaling approximately $37,051,608. 11. RELATED-PARTY TRANSACTIONS Net sales for the years ended May 31, 1998, 1997, and 1996 included $101,440,010, $110,678,770, and $124,299,369, respectively, to related parties. The operations of the Defined Business Unit purchases a portion of its soybeans from the Company, a related party. Included in cost of goods sold for the years ended May 31, 1998, 1997, and 1996 were $19,875,032, $5,726,038, and $3,772,327, 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 Oilseed Processing and Refining Defined Business Unit for the years ended May 31, 1998, 1997, and 1996 were $900,000, $825,000, and $750,000, 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:
1998 1997 1996 ----------- ------------ ------------ Net cash paid during the year for: Interest ........................ $380,030 $ 321,700 $ 151,500 Income taxes .................... 789,505 2,300,000 1,500,000
13. SUBSEQUENT EVENT Effective June 1, 1998, Harvest States Cooperatives combined with Cenex, Inc. to form Cenex Harvest States Cooperatives, and as such, EPUs now represent an ownership interest in Cenex Harvest States Cooperatives. F-26 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, 1998 and 1997 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, 1998. 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 audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, such financial statements present fairly, in all material respects, the financial position of the Wheat Milling Defined Business Unit at May 31, 1998 and 1997 and the results of its operations and its cash flows for each of the three years in the period ended May 31, 1998, in conformity with generally accepted accounting principles. Deloitte & Touche, LLP Minneapolis, MN July 24, 1998 F-27 WHEAT MILLING DEFINED BUSINESS UNIT (A DEFINED BUSINESS UNIT OF HARVEST STATES COOPERATIVES) BALANCE SHEETS MAY 31, 1998 AND 1997
1998 1997 -------------- -------------- ASSETS CURRENT ASSETS: Receivables (Note 2) ................................. $ 35,757,497 $ 26,860,772 Inventories (Note 3) ................................. 13,785,062 12,271,615 Prepaid expenses and deposits ........................ 393,085 840,730 ------------ ------------ Total current assets ............................... 49,935,644 39,973,117 OTHER ASSETS (Note 4) ................................. 10,747,876 11,814,555 PROPERTY, PLANT, AND EQUIPMENT (Note 5) ............... 85,627,365 69,130,520 ------------ ------------ $146,310,885 $120,918,192 ============ ============ LIABILITIES AND DEFINED BUSINESS UNIT EQUITY CURRENT LIABILITIES: Due to Harvest States Cooperatives (Note 6) .......... $ 16,738,969 $ 22,413,445 Accounts payable and accrued expenses ................ 10,404,665 9,493,405 Current portion of long-term debt (Note 6) ........... 10,005,000 10,005,000 ------------ ------------ Total current liabilities .......................... 37,148,634 41,911,850 LONG-TERM DEBT, less current portion (Note 6) ......... 41,204,270 51,209,270 COMMITMENTS AND CONTINGENCIES (Note 11) DEFINED BUSINESS UNIT EQUITY (Note 7) ................. 67,957,981 27,797,072 ------------ ------------ $146,310,885 $120,918,192 ============ ============
See notes to financial statements. F-28 WHEAT MILLING DEFINED BUSINESS UNIT (A DEFINED BUSINESS UNIT OF HARVEST STATES COOPERATIVES) STATEMENTS OF EARNINGS YEARS ENDED MAY 31, 1998, 1997, AND 1996
1998 1997 1996 --------------- --------------- --------------- REVENUES: Processed grain sales .......................... $205,281,433 $199,078,687 $173,315,613 Other income ................................... 1,820,294 ------------ ------------ ------------ 207,101,727 199,078,687 173,315,613 COSTS AND EXPENSES: Cost of goods sold ............................. 189,614,207 181,565,899 161,293,430 Marketing, general, and administrative ......... 8,071,913 6,749,237 4,471,563 Interest ....................................... 3,121,893 5,229,669 4,457,797 Other (Note 1) ................................. 162,283 2,000,000 ------------ ------------ ------------ 200,970,296 195,544,805 170,222,790 ------------ ------------ ------------ EARNINGS BEFORE INCOME TAXES .................... 6,131,431 3,533,882 3,092,823 INCOME TAXES (Note 10) .......................... 475,000 300,000 200,000 ------------ ------------ ------------ NET EARNINGS .................................... $ 5,656,431 $ 3,233,882 $ 2,892,823 ============ ============ ============
See notes to financial statements. F-29 WHEAT MILLING DEFINED BUSINESS UNIT (A DEFINED BUSINESS UNIT OF HARVEST STATES COOPERATIVES) STATEMENTS OF DEFINED BUSINESS UNIT EQUITY 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 Harvest States capital contributed ............... 38,800,000 Net earnings ..................................... 5,656,431 Defined business unit equity distributed ......... (4,295,522) ------------ BALANCE AT MAY 31, 1998 ........................... $ 67,957,981 ============
See notes to financial statements. F-30 WHEAT MILLING DEFINED BUSINESS UNIT (A DEFINED BUSINESS UNIT OF HARVEST STATES COOPERATIVES) STATEMENTS OF CASH FLOWS YEARS ENDED MAY 31, 1998, 1997, AND 1996
1998 1997 1996 --------------- --------------- ---------------- CASH FLOWS FROM OPERATING ACTIVITIES: Net earnings .......................................... $ 5,656,431 $ 3,233,882 $ 2,892,823 Adjustments to reconcile net earnings to net cash flows: Depreciation and amortization ....................... 4,717,198 4,137,440 3,309,307 Loss on impairment .................................. 162,283 2,000,000 Change in assets and liabilities: Receivables ........................................ (8,896,725) 16,888,362 (25,116,058) Inventories ........................................ (1,513,447) (2,963,340) (2,302,088) Prepaid expenses, deposits, and other .............. 447,645 (690,857) (51,007) Accounts payable and accrued expenses .............. 911,260 (2,986,937) 5,063,539 ------------- ------------- ------------- Total adjustments ................................ (4,171,786) 16,384,668 (19,096,307) ------------- ------------- ------------- Net cash provided by (used in) operating activities ...................................... 1,484,645 19,618,550 (16,203,484) CASH FLOWS FROM INVESTING ACTIVITIES: Acquisition of additional intangibles ................. (475,654) Acquisition of property, plant, and equipment ......... (20,309,651) (14,968,233) (18,080,009) ------------- ------------- ------------- Net cash used in investing activities ............ (20,309,651) (14,968,233) (18,555,663) CASH FLOWS FROM FINANCING ACTIVITIES: Net (repayments to) borrowings from Harvest States Cooperatives .................................. (5,674,472) (8,630,705) 17,401,970 Long-term debt borrowings ............................. 15,000,000 20,250,000 Capital from Harvest States Cooperatives .............. 38,800,000 Principal payments on long-term debt .................. (10,005,000) (7,785,730) Defined business unit equity distributed .............. (4,295,522) (3,233,882) (2,892,823) ------------- ------------- ------------- Net cash provided by (used in) financing activities ...................................... 18,825,006 (4,650,317) 34,759,147 ------------- ------------- ------------- INCREASE (DECREASE) IN CASH ............................ CASH AT BEGINNING OF YEAR .............................. ------------- ------------- ------------- CASH AT END OF YEAR .................................... $ -- $ -- $ -- ============= ============= =============
See notes to financial statements. F-31 WHEAT MILLING DEFINED BUSINESS UNIT (A DEFINED BUSINESS UNIT OF HARVEST STATES COOPERATIVES) NOTES TO FINANCIAL STATEMENTS YEARS ENDED MAY 31, 1998, 1997, AND 1996 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES ORGANIZATION AND NATURE OF BUSINESS -- Harvest States Cooperatives Wheat Milling Defined Business Unit (the Defined Business Unit) 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. 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. F-32 WHEAT MILLING DEFINED BUSINESS UNIT (A DEFINED BUSINESS UNIT OF HARVEST STATES COOPERATIVES) NOTES TO FINANCIAL STATEMENTS (CONTINUED) YEARS ENDED MAY 31, 1998, 1997, AND 1996 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) REVENUE FROM SIGNIFICANT CUSTOMERS -- Sales to two customers accounted for 23% and 11% of total sales for the year ended May 31, 1997 and 24% and 15% of total sales for the year ended May 31, 1996. NEW ACCOUNTING STANDARDS -- In June 1997, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS) No. 131, Disclosures About Segments of an Enterprise and Related Information, which relates to financial reporting of operating or business segments of a company. The new standard is effective for fiscal years beginning after December 15, 1997. Management is currently evaluating this new standard and has not yet determined its applicability or impact on the presentation of the Company's financial statements. In June 1998, FASB issued SFAS No. 133, ACCOUNTING FOR DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES, which relates to the accounting for derivative transactions and hedging activities. This new standard is effective for years beginning after June 15, 1999. While management does not believe this standard will materially impact the financial results of the Company, it is currently evaluating the reporting requirements under this new standard. 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, ------------------------------- 1998 1997 -------------- -------------- Trade ............................. $35,703,123 $26,857,249 Other ............................. 738,178 324,792 Less allowance for losses ......... (683,804) (321,269) ----------- ----------- $35,757,497 $26,860,772 =========== ===========
3. INVENTORIES
MAY 31, ------------------------------- 1998 1997 -------------- -------------- Grain ............................ $11,617,912 $10,556,495 Processed grain products ......... 1,395,277 1,295,324 Other ............................ 771,873 419,796 ----------- ----------- $13,785,062 $12,271,615 =========== ===========
4. OTHER ASSETS
MAY 31, ----------------------------- 1998 1997 ------------- ------------- Goodwill, less accumulated amortization of $1,594,995 and $1,188,315, respectively ........................................ $ 4,505,065 $ 4,911,744 Leasehold rights and other intangibles, less accumulated amortization of $5,670,602 and $5,144,723, respectively ......... 6,242,811 6,902,811 ----------- ----------- $10,747,876 $11,814,555 =========== ===========
F-33 WHEAT MILLING DEFINED BUSINESS UNIT (A DEFINED BUSINESS UNIT OF HARVEST STATES COOPERATIVES) NOTES TO FINANCIAL STATEMENTS (CONTINUED) YEARS ENDED MAY 31, 1998, 1997, AND 1996 5. PROPERTY, PLANT, AND EQUIPMENT
ESTIMATED MAY 31, USEFUL LIFE ----------------------------------- IN YEARS 1998 1997 ------------ ---------------- ---------------- Land .................................. $ 397,726 $ 397,726 Grain processing plants ............... 15 to 45 37,015,956 29,767,710 Machinery and equipment ............... 5 to 20 48,406,084 40,169,184 ------------- ------------- 85,819,766 70,334,620 Less accumulated depreciation ......... (21,399,153) (17,748,631) ------------- ------------- 64,420,613 52,585,989 Construction-in-progress .............. 21,206,752 16,544,531 ------------- ------------- $ 85,627,365 $ 69,130,520 ============= =============
During the years ended May 31, 1998, 1997, and 1996, the Defined Business Unit capitalized interest of $338,700, $588,731, and $739,101, 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 $16,738,969 and $22,413,445 were outstanding on May 31, 1998 and 1997, respectively. 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. The weighted average borrowing rate of the Company's short-term borrowings was 5.8% for each of the years ended May 31, 1998 and May 31, 1997, respectively. Amounts due from the Company will receive interest in the same manner at the same rate. Long-term borrowings:
MAY 31, ----------------------------------- 1998 1997 ---------------- ---------------- Harvest States Cooperatives, with fixed and variable interest rates from 6.41% to 8.75%, due in installments through 2005 ..... $ 49,359,270 $ 59,114,270 Industrial Development and Public Grain Elevator Revenue Bonds, payable through July 2004, with an interest rate of 7.4% .................................. 1,850,000 2,100,000 ------------- ------------- 51,209,270 61,214,270 Less current portion ............................................. (10,005,000) (10,005,000) ------------- ------------- $ 41,204,270 $ 51,209,270 ============= =============
The principal maturities of long-term indebtedness outstanding at May 31, 1998 are as follows: Year ending May 31: 1999 .................................. $10,005,000 2000 .................................. 10,005,000 2001 .................................. 8,130,000 2002 .................................. 7,125,000 2003 .................................. 7,125,000 2004 and thereafter ................... 8,819,270
F-34 WHEAT MILLING DEFINED BUSINESS UNIT (A DEFINED BUSINESS UNIT OF HARVEST STATES COOPERATIVES) NOTES TO FINANCIAL STATEMENTS (CONTINUED) YEARS ENDED MAY 31, 1998, 1997, AND 1996 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 ending 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. See Note 12 for discussion of the Company's capital contribution to the Defined Business Unit on June 1, 1997. 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 the years ended May 31, 1998, 1997, and 1996 were approximately $127,000, $136,000, and $46,000, 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:
1998 1997 -------------- -------------- Accumulated benefit obligation, including vested benefits of $84,901,955 and $75,515,800, respectively ......... $89,428,668 $77,644,611 Projected benefit obligation for service rendered to date ...... 94,075,077 78,660,275 Plan assets at fair value ...................................... 86,888,669 76,348,832
The determination of the actuarial present value of the projected benefit obligation was based on a weighted average discount rate of 7.00% in 1998, and 7.75% in 1997 and 1996, and a rate of increase in future compensation of 5.00% in 1998, 1997, and 1996. The expected long-term rate of return on plan assets was 8.50% in 1998 and 1997 and 8.00% in 1996. 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. F-35 WHEAT MILLING DEFINED BUSINESS UNIT (A DEFINED BUSINESS UNIT OF HARVEST STATES COOPERATIVES) NOTES TO FINANCIAL STATEMENTS (CONTINUED) YEARS ENDED MAY 31, 1998, 1997, AND 1996 9. POSTRETIREMENT MEDICAL AND OTHER BENEFITS (CONTINUED) The accrued postretirement medical and other benefits costs of the Company that are not funded were as follows at May 31:
1998 1997 --------------- --------------- Accumulated postretirement benefit obligation (APBO): Retirees ............................................ $ 4,469,542 $ 4,371,635 Fully eligible active plan participants ............. 1,290,572 775,433 Other active plan participants ...................... 4,500,895 3,032,288 ------------ ------------ Total APBO ......................................... 10,261,009 8,179,356 Unrecognized transition obligation ................... (7,970,082) (8,501,474) Unrecognized net gains ............................... 1,850,292 3,526,263 ------------ ------------ Accrued postretirement medical and other benefits cost $ 4,141,219 $ 3,204,145 ============ ============
The net periodic costs billed to the Defined Business Unit for the years ended May 31, 1998, 1997, and 1996 were approximately $72,000, $65,000, and $42,000, respectively. The calculations assumed a discount rate of 7.00% in 1998 and 7.75% in 1997 and 1996 and a health care cost trend rate of 9.00% in 1998, declining to 6.00% in 2004. If the health care cost trend rate increased by 1.00%, the APBO would increase by 7.30% and the service cost and interest cost components would increase by 9.90%. 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 were as follows:
1998 1997 1996 ---------- ---------- ---------- Statutory federal income tax rate ................. 35.0% 35.0% 35.0% State and local income taxes, net of federal income tax benefit ...................................... 5.0 4.9 4.3 Patronage earnings ................................ (36.5) (31.2) (35.6) Other ............................................. 4.2 ( .2) 2.8 ----- ----- ----- Effective rate .................................... 7.7% 8.5% 6.5% ===== ===== =====
11. COMMITMENTS AND CONTINGENCIES Leases for approximately 318 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. F-36 WHEAT MILLING DEFINED BUSINESS UNIT (A DEFINED BUSINESS UNIT OF HARVEST STATES COOPERATIVES) NOTES TO FINANCIAL STATEMENTS (CONTINUED) YEARS ENDED MAY 31, 1998, 1997, AND 1996 11. COMMITMENTS AND CONTINGENCIES (CONTINUED) Minimum rental payments due under these operating leases at May 31, 1998 are as follows:
MILLING RAIL CARS FACILITY OTHER TOTAL ------------- ------------ ---------- ------------- Years ending May 31: 1999 ........................ $2,278,640 $ 440,004 $32,902 $ 2,751,546 2000 ........................ 2,083,410 440,004 19,190 2,542,604 2001 ........................ 1,692,920 440,004 2,645 2,135,569 2002 ........................ 567,605 440,004 1,007,609 2003 ........................ 82,000 466,668 548,668 2004 and thereafter ......... 2,080,000 2,080,000 ---------- ---------- ------- ----------- $6,704,575 $4,306,684 $54,737 $11,065,996 ========== ========== ======= ===========
Total rent expense, net of rail car mileage credits received from the railroad and subleases, was $2,107,630, $2,144,838, and $1,624,576 for the years ended May 31, 1998, 1997, and 1996, respectively. Mileage credits and sublease income were $214,999, $375,667, and $338,700 for the years ended May 31, 1998, 1997, and 1996, 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, 1998, the operations of the Defined Business Unit had outstanding grain purchase contracts of approximately 7,846,000 bushels at prices for durum ranging from $5.00 per bushel to $6.55 per bushel and prices for spring wheat ranging from $3.98 per bushel to $4.35 per bushel. In addition, the operations of the Defined Business Unit had outstanding sales contracts of both semolina and commercial baking flour totaling approximately $61,657,285. 12. RELATED-PARTY TRANSACTIONS Net sales for the year ended May 31, 1998, 1997, and 1996 included $98,839, $753,583, and $647,416, 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, 1998, 1997, and 1996 were $141,454,000, $138,000,000, and $122,900,000, 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, 1998, 1997, and 1996 were $1,020,000, $1,000,000, and $950,000, respectively. On June 1, 1997, the Company contributed $38,800,000 in equity to the Defined Business Unit for the purpose of constructing a mill at Mount Pocono, Pennsylvania. F-37 WHEAT MILLING DEFINED BUSINESS UNIT (A DEFINED BUSINESS UNIT OF HARVEST STATES COOPERATIVES) NOTES TO FINANCIAL STATEMENTS (CONTINUED) YEARS ENDED MAY 31, 1998, 1997, AND 1996 13. SUPPLEMENTAL CASH FLOW STATEMENT INFORMATION Additional information concerning supplemental disclosures of cash flow activities for the years ended May 31 is as follows:
1998 1997 1996 ------------- ------------- ------------- Net cash paid during year for: Interest .................... $3,121,893 $5,229,669 $4,457,797 Income taxes ................ 475,000 300,000 200,000
14. SUBEQUENT EVENT Effective June 1, 1998 Harvest States Cooperatives combined with Cenex, Inc. to form Cenex Harvest States Cooperatives and, as such, EPUs now represent an ownership interest in Cenex Harvest States Cooperatives. F-38 EX-10.17 2 OPERATING AGREEMENT EXHIBIT 10.17 OPERATING AGREEMENT OF LAND O' LAKES/HARVEST STATES, L.L.C. This Operating Agreement is made as of the 30th day of May, 1998, by and between, Harvest States Cooperatives, a Minnesota cooperative corporation ("Harvest States") and Land O' Lakes, Inc., a Minnesota cooperative corporation ("Land O' Lakes"), collectively referred to herein as the "Members". For the consideration of the mutual covenants hereinafter set forth, the Members hereby agree as follows: SECTION ONE DEFINITIONS Section 1.01 Definitions. The terms defined in this Section One (except as may be otherwise expressly provided in this Agreement or unless the context otherwise requires) shall, for all purposes of this Agreement, have the following respective meanings: "Act" means the act described in Section 2.01 of this Agreement. "Agreement" means this Operating Agreement as hereafter amended from time to time, including all Schedules and Exhibits attached hereto. "Capital Account" means the account of a Member which is maintained in accordance with the provisions of Section 4.07 hereof. "Code" means the Internal Revenue Code of 1986, as amended and any successor thereto. Any reference herein to specific sections of the Code shall be deemed to include a reference to any corresponding provisions of future law. "Company" means Land O' Lakes/Harvest States Feeds, L.L.C., a Minnesota limited liability company. "Company Minimum Gain" has the meaning given the term "partnership minimum gain" in Regulation Sections 1.704-2(b)(2) and 1.704-2(d). "Defined Territory" shall mean that specific territory described in Schedule A attached hereto. "Depreciation" means, for each fiscal year, an amount equal to the depreciation, amortization, or other cost recovery deduction allowable with respect to an asset for such year, except that if the Gross Asset Value of an asset differs from its adjusted basis for federal income tax purposes at the beginning of such year, Depreciation shall be an amount which bears the same ratio to such beginning Gross Asset Value as the federal income tax depreciation, amortization, or other cost recovery deduction for such year bears to such beginning adjusted tax basis; provided, however, that if the adjusted basis for federal income tax purposes of an asset at the beginning of such year is zero, Depreciation shall be determined with reference to such beginning Gross Asset Value using any reasonable method selected by the Members. "Distribution" means the distributions to the Members of cash or other assets of the Company made from time to time pursuant to the provisions of this Agreement. "Feed Assets" shall mean those tangible and intangible feed assets contributed by Harvest States and Land O' Lakes pursuant to Schedules 4.08(a) and (b) attached hereto. "Feed Manager" means the individual hired by the Manager to oversee the day-to-day operations of the Company. "Financial Rights" means a Member's rights to share in Net Income and Net Losses and Distributions with respect to a Membership Interest in accordance with the terms of this Agreement. "Governance Rights" means all of a Member's rights as a Member in the Company other than Financial Rights and the right to assign Financial Rights. "Gross Asset Value" means with respect to any asset, the asset's adjusted basis or federal income tax purposes, except as follows: (i) The initial Gross Asset Value of any asset contributed by a Member to the Company shall be the gross fair market value of such asset, as determined by the Members, provided that the initial Gross Asset Values of the assets contributed to the Company pursuant to Schedule 4.08 shall be as set forth in such Schedule. (ii) The Gross Asset Values of all Company assets shall be adjusted to equal their respective gross fair market values (taking Code Section 7701(g) into account), as determined by the Members as of the following times: (A) the acquisition of an additional interest in the Company by any new or existing Member in exchange for more than a de minimis capital contribution; (B) the distribution by the Company to a Member of more than a de minimis amount of Company property as consideration for an interest in the Company; and (C) the liquidation of the Company within the meaning of Regulations Section 1.704-1(b)(2)(ii)(g), PROVIDED that an adjustment described in clauses (A) and (B) of this paragraph shall be made only if the Members reasonably determine that such adjustment is necessary to reflect the relative economic interests of the Members in the Company; (iii) The Gross Asset Value of any item of Company assets distributed to any Member shall be adjusted to equal the gross fair market value (taking Code Section 7701(g) into account) of such asset on the date of distribution as determined by the Members, and (iv) The Gross Asset Values of Company assets shall be increased (or decreased) to reflect any adjustments to the adjusted basis of such assets pursuant to Code Section 734(b) or Code Section 743(b) (if a section 754 election is in effect), but only to the extent that such adjustments are taken into account in determining Capital Accounts pursuant to Regulations Section 1.704-1(b)(2)(iv)(m) and subparagraph (vi) of the definition of "Profits" and "Losses"; provided, however, that Gross Asset Values shall not be adjusted pursuant to this subparagraph (iv) to the extent that an adjustment pursuant to subparagraph (ii) is required in connection with a transaction that would otherwise result in an adjustment pursuant to this subparagraph (iv). If the Gross Asset Value of an asset has been determined or adjusted pursuant to subparagraph (ii) or (iv), such Gross Asset Value shall thereafter be adjusted by the Depreciation taken into account with respect to such asset, for purposes of computing Profits and Losses. "Manager" means a person elected, appointed, or otherwise designated as a manager by the Members, and any other person considered elected as a manager pursuant to the Act. "Member" means a person reflected in the required records of the Company as the owner of some Governance Rights of a Membership Interest of the Company, as reflected on Schedule 4.01 attached hereto. "Membership Interest" means a Member's interest in the Company consisting of the Member's Financial Rights and Governance Rights with respect to the Company. "Member Nonrecourse Debt" has the meaning given the term "partner nonrecourse debt" in Regulation Sections 1.704-2(b)(4). "Member Nonrecourse Debt Minimum Gain" means an amount, with respect to each Member Nonrecourse Debt, equal to the Company Minimum Gain that would result if such Member Nonrecourse Debt were treated as a Nonrecourse Liability, determined in accordance with Regulation Section 1.704-2(i)(3). "Member Nonrecourse Deductions" has the meaning given the term "partner nonrecourse deductions" in Regulation Sections 1.704-2(i)(1) and 1.704(i)(2). "Net Income" and "Net Losses" mean respectively the profits and losses of the Company, as the case may be, as determined for federal income tax purposes as of the close of each of the fiscal years of the Company. "Nonrecourse Deductions" has the meaning set forth in Regulation Section 1.704-2(b)(1). "Nonrecourse Liability" has the meaning set forth in Regulation Sections 1.704-2(b)(3). "Profits and Losses" mean, for each fiscal year, an amount equal to the Company's taxable income or loss for such year, determined in accordance with Code Section 703(a) (For this purpose, all items of income, gain, loss, or deduction required to be stated separately pursuant to Code Section 703(a)(1) shall be included in taxable income or loss), with the following adjustments (without duplication): (i) Any income of the Company that is exempt from federal income tax and not otherwise taken into account in computing Profits and Losses pursuant to this definition of "Profits" and "Losses" shall be added to such taxable income or loss; (ii) Any expenditures of the Company described in Code Section 705(a)(2)(B) or treated as Code Section 705(a)(2)(B) expenditures pursuant to Regulations Section 1.704-1(b)(2)(iv)(i), and not otherwise taken into account in computing Profits or Losses pursuant to this definition of"Profits" and "Losses" shall be subtracted from such taxable income or loss; (iii) In the event the Gross Asset Value of any Company asset is adjusted pursuant to subparagraphs (ii) or (iii) of the definition of Gross Asset Value, the amount of such adjustment shall be treated as an item of gain (if the adjustment increases the Gross Asset Value of the asset) or an item of loss (if the adjustment decreases the Gross Asset Value of the asset) from the disposition of such asset and shall be taken into account for purposes of computing Profits or Losses; (iv) Gain or loss resulting from any disposition of Property with respect to which gain or loss is recognized for federal income tax purposes shall be computed by reference to the Gross Asset Value of the Property disposed of, notwithstanding that the adjusted tax basis of such Property differs from its Gross Asset Value; (v) In lieu of the depreciation, amortization, and other cost recovery deductions taken into account in computing such taxable income or loss, there shall be taken into account Depreciation of such year, computed in accordance with the definition of Depreciation. (vi) To the extent an adjustment to the adjusted tax basis of any Company asset pursuant to Code Section 734(b) is required, pursuant to Regulations Section 1.704(b)(2)(iv)(m)(4), to be taken into account in determining Capital Accounts as a result of a distribution other than in liquidation of a Member's interest in the Company, the amount of such adjustment shall be treated as an item of gain (if the adjustment increases the basis of the asset) or loss (if the adjustment decreases such basis) from the disposition of such asset and shall be taken into account for purposes of computing Profits or Losses; and (vii) Notwithstanding any other provision of this definition, any items which are specially allocated pursuant to Section 5.01 or Section 5.02 hereof shall not be taken into account in computing Profits or Losses. The amounts of the items of Company income, gain, loss or deduction available to be specially allocated pursuant to Sections 5.01 and 5.02 hereof shall be determined by applying rules analogous to those set forth in subparagraphs (i) through (vi) above. SECTION TWO FORMATION, NAME AND GENERAL PURPOSE Section 2.01 Formation. The Members hereby form a limited liability company (the "Company") pursuant to the and the terms of this Agreement effective upon the filing of the Articles of Organization for the Company with the Minnesota Secretary of State. The Members shall execute and acknowledge any and all certificates and instruments and do all filing, recording and other acts as may be appropriate to comply with the requirements of the Act relating to the formation, operation and maintenance of the Company in accordance with the terms of this Agreement. The Company shall commence business operations on June 1, 1998. Section 2.02 Intended Treatment. The Members intend that the Company shall be operated in a manner consistent with its treatment as a "partnership" for federal and state income tax purposes. No Member shall take any action inconsistent with the express intent of the parties hereto. It is expressly provided, however, that the Members do not intend that the Company be treated as a "partnership" for purposes of Section 303 of the Bankruptcy Code. Section 2.03 Name. The name of the Company shall be Land O' Lakes/Harvest States Feeds, L.L.C. Section 2.04 Registered Office; Principal Executive Office. The Company's registered office and principal office shall be located at 5500 Cenex Drive, Inver Grove Heights, MN 55077. Section 2.05 General Purposes and General Powers. The purposes of the Company shall be to operate and manage a business for the manufacture, marketing, and sale of animal feed products at wholesale (and retail sales from the feed mills operated by the Company), and development of livestock production and actual livestock production in the Defined Territory on behalf of and as agent for the Members, and for the operation of such other related activities as may be necessary to carry out said purposes. The Company shall not engage in any other business purposes without the unanimous approval of its Members. Except as otherwise set forth in this Agreement, the Company shall have all of those powers set forth in the Minnesota Limited Liability Company Act. Section 2.06 Term. The term of the Company shall commence upon the filing of the Articles of Organization and shall have a perpetual duration, unless dissolved earlier according to law and/or the terms hereof. Section 2.07 Initial Members. The name and address of each of the initial Members are as follows: Land O' Lakes, Inc. Harvest States Cooperatives 5500 Cenex Drive 5500 Cenex Drive Inver Grove Heights, MN 55077 Inver Grove Heights, MN 55077 SECTION THREE GOVERNANCE; CONDUCT OF OPERATIONS Section 3.01 Governance. Except as set forth herein or otherwise required by statute, the Company shall be governed by the Members as set forth in Section 8. Section 3.02 Trademark License Agreement with Members. The Company will enter into a Trademark License Agreement with each Member for the exclusive use by the Company in the Defined Territory of certain trademarks in connection with the manufacture and wholesale distribution of feeds and feed ingredients. Such Trademark License Agreements shall be substantially in the form of Schedule 3.02, attached hereto and made a part hereof. Section 3.03 Ingredient Purchase Agreement. The Company will enter into an Ingredient Purchase Agreement with Land O' Lakes pursuant to which the Company will purchase from Land O' Lakes all of the Company's needs for premix products, vitamins, and minerals. The Ingredient Purchase Agreement is attached hereto and made a part hereof as Schedule 3.03. Section 3.04 Facilities Lease Agreements. The Company will enter into Facilities Lease Agreements with Land O' Lakes and Harvest States pursuant to which the Company will lease some or all of the Feed Assets from Land O' Lakes and Harvest States. The Facilities Lease Agreements are attached hereto as Schedule 3.04. Section 3.04. Emplovee Leases. The Company will enter into the Land O' Lakes Employee Lease with Land O' Lakes and the Harvest States Employee Lease pursuant to which the Company will lease from Land O' Lakes and Harvest States all of the Company's needs for the operations therein described. The Land O' Lakes Employee Lease and Harvest States Employee Lease are attached hereto and made a part hereof as Schedule 3.04. Section 3.05 Services Agreements; No Employees. Unless otherwise agreed in accordance with Section 3.01, the Company shall hire no employees but, rather, shall enter into appropriate services agreements with entities and/or individuals as approved by the Members. The Company shall further enter into a Services Agreement with the Members in form and substance to be mutually agreed upon by the Members. Section 3.06 Periodic Audit. Unless otherwise unanimously agreed by the Members, the books and records of the Company shall be audited annually as of the fiscal year end of the Company by the accounting firm serving Harvest States. The books of the Company shall be closed twice per year on August 31 and December 31. SECTION FOUR MEMBERSHIP INTERESTS Section 4.01 Membership Interests and Board Authority as to Additional Membership Interests. The names of the Members and their respective contributions and the agreed value thereof are reflected on Schedule 4.01, which is attached hereto and incorporated herein by reference. No additional contributions shall be accepted and no additional Membership Interests shall be granted by the Board without the consent of one hundred percent (100%) of the outstanding Governance Rights. Upon such consent and the issuance of additional Membership Interests, Schedule 4.01 shall be appropriately amended. Section 4.02 Terms of Membership Interests. The original Membership Interests reflected in Schedule 4.01 are ordinary membership interests of one class, without series, and shall have the rights provided by law, subject to any statement in this Agreement of the specific rights or terms of such Membership Interests. Section 4.03 Allocation of Profits and Losses. After giving effect to the special allocations set forth in Section Five, Profits for any fiscal year shall be allocated to the Members in proportion to their Financial Rights as reflected on Schedule 4.01. After giving effect to the special allocations set forth in Section Five, and subject to Section 5.05, Losses for any fiscal year shall be allocated to the Members in proportion to their Financial Rights as reflected on Schedule 4.01. Section 4.04 Operating Distributions. Any distributions authorized by the Board other than Liquidating Distributions pursuant to Section 4.05 shall be distributed among the Members based on their Financial Rights as reflected on Schedule 4.01. Section 4.05 Liquidating Distributions. If the Company is dissolved and its business is being liquidated, the Company shall cease to carry on its business, except to the extent necessary for the winding up of the business of the Company. The Company shall thereafter be wound up and terminated as provided hereunder and by the Act. All tangible or intangible property of the Company, including money, remaining after the discharge of the debts, obligations, and liabilities of the Company shall be distributed to the Members: (a) to the Members in proportion to, and to the extent of, the positive balances in their Capital Accounts; and (b) to the Members in accordance with their Financial Rights as set forth on Schedule 4.01. Section 4.06 Voting. Except with respect to those items set forth on Schedule 4.06 which shall require unanimous consent, or except as otherwise specifically provided herein or required by law, Members shall be entitled to vote on all matters in proportion to their Governance Rights as set forth on Schedule 4.01. Section 4.07 Capital Accounts. A separate Capital Account shall be maintained for each Member. Each Member's Capital Account shall be (I) increased by (a) the amount of money contributed by such Member, (b) the Fair Value of property contributed by such Member (net of liabilities secured by such contributed property that the Company is considered to assume or take subject to under Code Section 752), (c) allocations to such Member, pursuant to Article V, of Company income and gain (or items thereof), and (d) to the extent not already netted out under clause (ii) (b) below, the amount of any Company liabilities assumed by the Member or which are secured by any property distributed to such Member; and (ii) decreased by (a) the amount of money distributed to such Member, (b) the Fair Value of property distributed to such Member (net of liabilities secured by such distributed property that such Member is considered to assume or take subject to under Cold Section 752), (c) allocations to such Member, pursuant to Article V, of Company loss and deductions (or items thereof), and (d) to the extent not already netted out under clause (I) (b) above, the amount of any liabilities of the Member assumed by the Company or which are secured by any property contributed by such Member to the Company. The foregoing provisions of this Section 4.07 and the other provisions of this Agreement relating to the maintenance of the Capital Accounts are intended to comply with Treasury Regulation ss.ss.1.704-1(b) and 1.704-2, and shall be interpreted and applied in a manner consistent with such Treasury Regulations. In the event the Members determine that it is prudent or advisable to modify the manner in which the Capital Accounts, or any increases or decreases thereto, are computed in order to comply with such treasury Regulations, the Members may cause such modification to be made provided that it is not likely to have a material effect on the amounts distributable to either Member upon the dissolution of the Company. Section 4.08 Initial Capital Contributions. As requested by the Company, and on a pro rata basis based on each Member's Financial Rights, the initial Members shall make the following contributions to the capital of the Company: (a) Harvest States shall contribute the Harvest States Feed Assets as set forth on attached Schedule 4.08(a). (b) Land O' Lakes shall contribute the Land O' Lakes Feed Assets as set forth on attached Schedule 4.08(b). Section 4.09 Additional Capital Contributions. Except to the extent to pay for reasonable expenses customarily and regularly incurred in connection with the Agreements referenced in Section Three, no Member shall have any obligation to make additional capital contributions to the Company or to fund, advance, or loan money which may be necessary to pay deficits, if any, incurred by the Company during the term hereof. Members may make loans to the Company from time to time, as authorized by the Board. Any payment or transfer accepted by the Company from a Member which is not a capital contribution complying with Section 4.01 shall be deemed a loan and shall neither be treated as a contribution to the capital of the Company for any purpose hereunder, nor entitle such Member (as such) to any increase in such Member's Financial Rights or Governance Rights. Any such loan shall be repaid at such times and with such interest (at rates not to exceed the maximum permitted by law) as the Board and the lending Member shall reasonably agree. Section 4.10 Statement of Membership Interest. At the request of any Member, the Company shall state in writing the particular Membership Interest owned by that Member as of the moment the Company makes the statement. The statement must describe the Member's rights to vote, to share in profits and losses, and to share in distributions, restrictions on assignment(s) of Financial Rights and/or Governance Rights, as well as any assignment of the Member's rights then in effect other than a security interest. Section 4.11 Declaration of Distributions. The Members shall have the authority to declare distributions upon the Membership Interests of the Company to the extent permitted by law. SECTION FIVE SPECIAL ALLOCATION PROVISIONS Section 5.01 Tax Allocations. (i) Minimum Gain Chargeback. Except as otherwise provided in Section 1.704-2(f) of the Regulations, notwithstanding any other provision of this Section 5, if there is a net decrease in Company Minimum Gain during any Company fiscal year, each Member shall be specially allocated items of Company income and gain for such fiscal year (and, if necessary subsequent fiscal years) in an amount equal to such Person's share of the net decrease in Company Minimum Gain, determined in accordance with Regulations Section 1.704-2(g). Allocations pursuant to the previous sentence shall be made in proportion to the respective amounts required to be allocated to each Member pursuant thereto. The items to be so allocated shall be determined in accordance with Sections 1.704-2(f)(6) and 1.704-2(j)(2) of the Regulations. This Section 5.01(i) is intended to comply with the minimum gain chargeback requirement in Section 1.704-2(f) of the Regulations and shall be interpreted consistently therewith. (ii) Member Minimum Gain Chargeback. Except as otherwise provided in Section 1.704-2(i)(4) of the Regulations, notwithstanding any other provision of this Section 5, if there is a net decrease in Member Nonrecourse Debt Minimum Gain attributable to a Member Nonrecourse Debt during any Company fiscal year, each Person who has a share of the Member Nonrecourse Debt Minimum Gain attributable to such Member Nonrecourse Debt, determined in accordance with Section 1.704-2(i)(5) of the Regulations, shall be specially allocated items of Company income and gain for such fiscal year (and, if necessary, subsequent fiscal years) in an amount equal to such Person's share of the net decrease in Member Nonrecourse Debt Minimum gain attributable to such Member Nonrecourse Debt, determined in accordance with Regulations Section 1.704-2(i)(4). Allocations pursuant to the previous sentence shall be made in proportion to the respective amounts required to be allocated to each Member pursuant thereto. The items to be so allocated shall be determined in accordance with Sections 1.704-2(i)(4) and 1.704-2(j)(2) of the Regulations. This Section 5.01(ii) is intended to comply with the minimum gain chargeback requirement in Section 1.704-2(i)(4) of the Regulations and shall be interpreted consistently therewith. (iii) Oualified Income Offset. In the event any Member unexpectedly receives any adjustments, allocations, or distributions described in Regulations Section 1.704-l(b)(2)(ii)(d)(4), Regulations Section 1.704-l(b)(2)(ii)(d)(5), or Regulations Section 1.704-1(b)(2)(ii)(d)(6), items of Company income and gain shall be specially allocated to each such Member in an amount and manner sufficient to eliminate, to the extent required by the Regulations, the Adjusted Capital Account Deficit of such Member as quickly as possible, provided that an allocation pursuant to this Section 5.01(iii) shall be made if only to the extent that such Member would have Adjusted Capital Account Deficit after all other allocations provided for this Section 5 have been tentatively made as if this Section 5.01(iii) were not in the Agreement. (iv) Gross Income Allocation. In the event any Member has a deficit Capital Account at the end of any Company Fiscal Year which is in excess of the sum of (i) the amount such Member is obligated to restore (pursuant to the terms of such Member's Promissory Note or otherwise), and (ii) the amount such Member is deemed to be obligated to restore pursuant to the penultimate sentences of Regulations Sections 1.704-2(g)(1) and 1.704-2(i)(5), each such Member shall be specially allocated items of Company income and gain in the amount of such excess as quickly as possible, provided that an allocation pursuant to this Section 5.01(iv) shall be made if and only to the extent that such Member would have a deficit Capital Account in excess of such sum after all other allocations provided for this Section 5 have been tentatively made as if this Section 5.01(iv) and Section 5.01(iii) here of were not in the Agreement. (v) Nonrecourse Deductions. Nonrecourse Deductions for any Fiscal Year shall be allocated to the Members in accordance with their Financial Rights in the Company, as reflected in Schedule 4.01. (vi) Member Nonrecourse Deductions. Any Member Nonrecourse Deductions for any fiscal year shall be specially allocated to the Member or Members who bear the economic risk of loss with respect to the Member Nonrecourse Debt to which such Member Nonrecourse Deductions are attributable in accordance with Regulations Section 1.704-2(i)(1). (vii) Code Section 754 Adjustment. To the extent an adjustment to the adjusted tax basis of any Company asset pursuant to Code Section 734(b) or Code Section 743(b) is required (if a section 754 election is in effect), pursuant to Regulation Section 1.704-1(b)(2)(iv)(m)(2) or Regulation Section 1.704-1(b)(2)(iv)(m)(4), to be taken into account in determining Capital Accounts as a result of a distribution to a Member in complete liquidation of his interest, the amount of such adjustment to the Capital Accounts shall be treated as an item of gain (if the adjustment increases the basis of the asset) or loss (if the adjustment decreases such basis) and such gain or loss shall be specifically allocated to the Members in accordance with their interests in the Company in the event Regulation Section 1.704-1(b)(2)(iv)(m)(2) applies, or the Members to whom such distribution was made in the event that Regulation Section 1.704-1(b)(2)(iv)(m)(4) applies. 5.02 Curative Allocations. The allocations set forth in Sections 5.01 (i), (ii), (iii), (iv), (v), (vi), and (vii) hereof (the "Regulatory Allocations") are intended to comply with certain requirements of the Regulations. It is the intent of the Members that, to the extent possible, all Regulatory Allocations shall be offset either with other Regulatory Allocations or with special allocations of other items of Company income, gain, loss, or deduction pursuant to this Section 5.02. Therefore, notwithstanding any other provision of this Section 5 (other than the Regulatory Allocations), the Member(s) shall make such offsetting special allocations of Company income, gain, loss, or deduction in whatever manner they determine appropriate so that, after such offsetting allocations are made, each Member's Capital Account balance is, to the extent possible, equal to the Capital Account balance such Member would have had if the Regulatory Allocations were not part of the Agreement and all Company items were allocated pursuant to Section 4.03. In exercising its discretion under this Section 5.02, the Members shall take into account future Regulatory Allocations under Sections 5.01(i) and (ii) that, although not yet made, are likely to offset Regulatory Allocations made under Section 5.01(v) and Section 5.01(vi). 5.03 Other Allocation Rules (a) The Members are aware of the income tax consequences of the allocations made by this Section 5 and hereby agree to be bound by the provisions of this Section 5 in reporting their shares of Company income and loss for income tax purposes. (b) Solely for purposes of determining a Member's proportionate share of the "excess nonrecourse liabilities" of the Company within the meaning of Regulations Section 1.752-3(a)(3), the Members' interests in Company profits are the Members' Financial Rights in the Company, as reflected on Schedule 4.01 hereof. 5.04 Tax Allocations Code Section 704(c). In accordance with Code Section 704(c) and the Regulations thereunder, income, gain, loss, and deduction with respect to any property contributed to the capital of the Company shall, solely for tax purposes, be allocated among the Members so as to take account of any variation between the adjusted basis of such property to the Company for federal income tax purposes and its initial Gross Asset Value. In the event the Gross Asset Value of any Company asset is adjusted due to a revaluation of Company assets under Regulation Section 1.704-l(b)(2)(iv)(f), subsequent allocations of income, gain, loss, and deduction with respect to such asset shall take account of any variation between the adjusted basis of such asset for federal income tax purposes and its Gross Asset Value in the same manner as under Code Section 704(c) and the Regulations thereunder. The Members hereby agree that any allocations described in this Section 5.04, relating to tax allocations under section 704(c), shall be determined in accordance with the traditional method of making section 704(c) allocations as described in Regulation Section 1.704-3(b). Allocations pursuant to this section 5.04 are solely for purposes of federal, state, and local taxes and shall not affect, or in any way be taken into account in computing, any Member's Capital Account or share of Profits, Losses, other items, or distributions pursuant to any provisions of this Agreement. 5.05 Loss Limitation. Losses allocated pursuant to Section 4.03 hereof shall not exceed the maximum amount of Losses that can be allocated without causing any Member to have an Adjusted Capital Account Deficit at the end of any fiscal year. In the event some but not all of the Members would have Adjusted Capital Account Deficits as a consequence of an allocation of Losses pursuant to Section 4.03 hereof, the limitations set forth in this Section 5.05 shall be applied on a Member by Member basis and Losses not allocable to any Member as a result of such limitation shall be allocated to the other Members in accordance with the positive balances in such Member's Capital Accounts so as to allocate the maximum permissible Losses to each Member under Regulation Section 1.704(b)(2)(ii)(d). SECTION SIX TRANSFER OF INTERESTS Section 6.01 Transfers. A Member may assign the Member's full Membership Interest only by assigning all of the Member's Governance Rights coupled with a simultaneous assignment to the same assignee of all of the Member's Financial Rights. Any assignment of any Governance Rights or Financial Rights is effective only if: (i) all the Members, other than the Member seeking to make the assignment, approve the assignment by unanimous written consent, which consent may be given or withheld, conditioned or delayed as the remaining Members may determine in their sole discretion, and (ii) if the assignee executes this Agreement as amended to reflect such assignee's interest in the Company and any other instrument or instruments that the remaining Members may deem necessary or desirable to effect such assignment. SECTION SEVEN RIGHTS AND OBLIGATIONS OF MEMBERS Section 7.01 Limitation of Liability. Each Member's liability for the debts and obligations of the Company shall be limited as set forth in Minnesota Code Section 490A.601 and other applicable law. Section 7.02 Access to Company Records. Upon the written request of any Member, the Company shall allow any Member to inspect and copy, at the Member's expense, all Company records. Section 7.03 Dedication of Assets; Exclusive Use Covenants. As part of the consideration for formation of the Company, Land O' Lakes and Harvest States have agreed, subject to exceptions described in this Agreement, to dedicate the use of all of their respective current and future wholesale feed assets within the Defined Territory to the use of the Company within the Defined Territory. Except for existing operations of any Member set forth on Schedule 7.03, no Member shall, without the unanimous written consent of all other Members, directly or indirectly own, operate or engage in the manufacture, wholesale marketing or wholesale sale of animal feeds or animal feed products in the Defined Territory in competition with the Company; provided, however, that no consent shall be required if the Member agrees to sell any competing wholesale feed business acquired by the Member to the Company in accordance with Section 7.04. If a Member violates the terms of this Section 7.03 the other Member's sole remedy shall be to terminate this Agreement and dissolve the Company in accordance with Section Thirteen. Section 7.04 Additional Feed Assets. It is the intent of the Members that Harvest States and Land O' Lakes shall transfer the assets used in the manufacture or wholesale marketing of animal feed and described on Schedule A to the Company upon its formation. If after the formation of the Company, Harvest States or Land O' Lakes acquire additional wholesale feed assets, (whether by acquisition, merger, consolidation or otherwise) within the Defined Territory, the acquiring Member shall not be deemed in violation of Section 7.03 if such Member leases said assets and sells said competing business to the Company. The purchase price for any such business shall be as mutually agreed upon by the Members. In the event the Members are unable to so agree, the purchase price for the business shall be its value on a going-concern basis, to be determined as follows: Each Member shall, at its own expense, select a disinterested, MAI-certified appraiser. The two appraisers so selected shall select a third disinterested, MAI-certified appraiser, and the three shall proceed to value the assets in question as rapidly as possible. The purchase price shall be the average of the three appraisals. The costs of the third appraiser shall be shared equally by the Members. Section 7.05 Relations between Members. Except as otherwise expressly provided herein, nothing in this Agreement shall be deemed to restrict in any way the freedom of any of the Members to conduct any other business or activity whatsoever. Except as expressly provided herein, no Member shall have any authority to act for, or to assume any obligations or responsibilities on behalf of, the Company or any other Member. The creation of the Company shall not convey to a Member, by operation of law or otherwise, any interest in, right to, or ownership of any asset or property of the other Member. No Member shall become responsible for any of the debts, obligations or liabilities of the other, and no Member shall be constituted the agent or attorney in fact of the other. Any transaction unrelated to the purposes of the Company engaged in by a Member shall be solely the liability and responsibility of such Member, who shall not be authorized to bind any other Member as agent or otherwise with respect to such transaction. SECTION EIGHT MEMBER MEETINGS; MANAGEMENT Section 8.01 Management. The business and affairs of the Company shall be managed by the Members in accordance with this Article Eight. All decisions concerning the management of the Company's Business shall be made by the Members acting through the Member's Representatives and the officers of the Company as provided in Section Nine. Except upon the express authorization or designation by the Members or the Member Representatives acting in accordance with this Agreement, no Member shall have any unilateral right or authority to take any action on behalf of the Company with respect to third parties. Each Member Representative shall be an officer, director or employee of the appointing Member. The Member Representatives shall serve as such without compensation. Section 8.02 Place of Meetings. Each meeting of the Members shall be held at the principal office of the Company located at Inver Grove Heights, Minnesota, or at such other place as may be agreed upon by the Members provided, however, that any meeting called by or at the demand of a Member or Members shall be held in the principal office of the Company. Section 8.03 Regular Meetings. Regular meetings of the Members shall be held at least on an annual basis and on a more frequent basis if agreed upon by the Members. At each regular meeting the Members entitled to vote may transact any business, provided, however, that no business with respect to which special notice is required by law shall be transacted unless such notice shall have been given. Section 8.04 Special Meetings. A special meeting of the Members may be called for any purpose or purposes at any time by the Feed Manager; by the Treasurer or by one or more Members owning not less than ten percent of the Governance Rights, who shall demand such special meeting by written notice given to the Feed Manager or the Treasurer of the Company specifying the purposes of such meeting. Section 8.05 Meetings Held Upon Member Demand. Within 30 days after receipt of a demand by an officer of any Member entitled to call a meeting of the Members, it shall be the duty of the Manager to cause a special or regular meeting of Members, as the case may be, to be duly called and held on notice no later than 90 days after receipt of such demand. Section 8.06 Adjournments. Any meeting of the Members may be adjourned from time to time to another date, time and place within 120 days after the date fixed for the original meeting. If any meeting of the Members is so adjourned, no notice as to such adjourned meeting need be given if the date, time and place at which the meeting will be reconvened are announced at the time of adjournment. Section 8.07 Notice of Meetings. Unless otherwise required by law, written notice of each meeting of the Members, stating the date, time and place and, in the case of a special meeting, the purpose or purposes, shall be given at least ten days and not more than 60 days prior to the meeting to every owner of Membership Interests entitled to vote at such meeting except as specified in Section 7.05 or as otherwise permitted by law. The business transacted at a special meeting of Members is limited to the purposes stated in the notice of the meeting. Section 8.08 Waiver of Notice. A Member may waive notice of the date, time, place and purpose or purposes of a meeting of Members. A waiver of notice by a Member entitled to notice is effective whether given before, at or after the meeting, and whether given in writing, orally or by attendance. Attendance by a Member at a meeting is a waiver of notice of that meeting, unless the Member objects at the beginning of the meeting to the transaction of business because the meeting is not lawfully called or convened, or objects before a vote on an item of business because the item may not lawfully be considered at that meeting and does not participate in the consideration of the item at that meeting. Section 8.09 Action Without a Meeting. Any action required or permitted to be taken at a meeting of the Members of the Company may be taken without a meeting by written action signed by all of the Members entitled to vote on that action. Section 8.10 Quorum. For purposes of Member meetings, a quorum shall consist of those Member Representatives (as defined in Section 8.11) eligible to cast one hundred percent (100%) of the outstanding Governance Rights. A quorum shall be required to conduct business at any Member meeting. Section 8.11 Member Representatives. Each Member may designate its representative(s) who shall vote and act on such Member's behalf at membership meetings ("Member Representative(s)") and with respect to all matters to be acted upon by the Members under the terms of this Agreement. Until all Members are notified to the contrary, the following individuals shall act as Member Representative(s) of the respective Members as follows: HARVEST STATES LAND O' LAKES 1. Michael Bergeland 1. Bob DeGregorio 2. David Swenson 2. Duane Halverson Any Member Representative shall have the authority to vote the entire Governance Rights of the Member he or she represents. SECTION NINE OFFICERS Section 9.01 Number and Designation. The Company shall have one or more natural persons exercising the functions of the position of Land O' Lakes/Harvest States Feeds, L.L.C., Manager, Treasurer, and Secretary. The Members shall elect the Company's Manager, Treasurer, and Secretary, and may elect or appoint such other managers or agents as it deems necessary for the operation and management of the Company, with such powers, rights, duties and responsibilities as may be determined by the Board, each of whom shall have the powers, rights, duties and responsibilities set forth in this Agreement unless otherwise determined by the Board. Any of the above positions may be held by the same person. Section 9.02 Company Manager. Unless provided otherwise by a resolution adopted by the Members, the Company Manager (a) shall have general active management of the business of the Company; (b) shall, when present, preside at all meetings of the Members and Board; c) shall see that all orders and resolutions of the Board are carried into effect; (d) may maintain records of and certify proceedings of the Board and Members; (e) shall execute and deliver in the name of the Company contracts and the like within authority as granted by the Members; and (f) shall perform such other duties as may from time to time be prescribed by the Board. The Company Manager shall be an employee of either Land O' Lakes or of Harvest States and shall perform the above duties pursuant to either the Land O' Lakes Employee Lease described in Section 3.04 or the Harvest States Employee Lease described in Section 3.05. Section 9.03 Treasurer. Unless provided otherwise by a resolution adopted by the Members, the Treasurer (a) shall keep accurate financial records for the Company; (b) shall deposit all money, drafts and checks in the name of and to the credit of the Company in such banks and depositories as the Board shall designate from time to time; c) shall endorse for deposit all notes, checks and drafts received by the Company as ordered by the Board, making proper vouchers therefor; (d) shall disburse Company funds and issue checks and drafts in the name of the Company, as ordered by the Board; (e) shall render to the Company Manager and the Board, whenever requested, an account of all of such manager's transactions as Treasurer and of the financial condition of the Company; and (f) shall perform such other duties as may be prescribed by the Board or the Company Manager from time to time. Section 9.04 Secretary. The Secretary, unless otherwise determined by the Members, shall attend all meetings of the Members and all meetings of the Board, shall record or cause to be recorded all proceedings thereof in a book to be kept for that purpose, and may certify such proceedings. Except as otherwise required or permitted by law or by this Agreement, the Secretary shall give or cause to be given notice of all meetings of the Members and all meetings of the Board. Section 9.05 Authority and Duties. In addition to the foregoing authority and duties, all officers of the Company shall respectively have such authority and perform such duties in the management of the business of the Company as may be designated from time to time by the Members. Unless prohibited by a resolution approved by the Board, any officer other than the Company Manager may, without the approval of the Board, delegate some or all of the duties and powers of a position to other persons. Section 9.06 Term, Resignation and Removal, Vacancy. All officers of the Company shall hold office until their respective successors are chosen and have qualified or until their earlier death, resignation or removal. An officer may resign at any time by giving written notice to the Company. The resignation is effective without acceptance when the notice is given to the Company, unless a later effective date is specified in the notice. An officer may be removed at any time, with or without cause, by a resolution unanimously approved by all of the Members. A vacancy in an officer's position because of death, resignation, removal, disqualification or other cause, shall be filled for the unexpired portion of the term by the unanimous consent of all of the entire Members. Section 9.07 Salaries. The salary of the Company Manager of the Company shall be approved by the Members. The salaries of any other officers shall be fixed by the Company Manager. Section 9.08 Required Records. At the expense of the Company, the Secretary shall maintain at a minimum the following records ("Required Records") at the Company's principal office: (a) A current list of the full name and last known business, residence or mailing address of each Member, Substituted Member, Manager, and Governor, both past and present; (b) A current list of the full name and last known business, residence, or mailing address of each assignee of Financial Rights other than a secured party, and a description of the rights assigned; (c) A copy of the Articles of Organization of the Company and all amendments thereto, together with executed copies of any powers of attorney pursuant to which any amendment has been executed; (d) Copies of the Company's currently effective written Operating Agreement and all amendments thereto, copies of any similar prior written agreements no longer in effect, and copies of any writings permitted or required with respect to a Member's obligation to contribute cash, property, or services; (e) Copies of the Company's federal, state and local income tax returns and reports for the three most recent years; (f) Records of all proceedings of Members for the last three years; (g) Reports made to Members generally within the last three years; (h) Copies of financial statements of the Company; (i) Minutes of every annual or special meeting of the Members; (j) Any written consents obtained from Members for actions taken by Members without a meeting; (k) Minutes of every annual or special meeting of the Members; (l) A statement of all contributions accepted; (m) A statement of all contribution agreements; (n) A statement of all contribution allowance agreements; (o) An explanation of any restatement of value; and (p) Any written consents obtained from Members. SECTION TEN INDEMNIFICATION Section 10.01 Indemnification By Company. The Company shall indemnify its Members, Member Representatives and Officers for such expenses and liabilities, in such manner, under such circumstances, and to such extent, as required or permitted by Minnesota Statutes Section 322B.699, as amended from time to time, or as required or permitted by other provisions of law. Section 10.02 Indemnification By Members. Each Member shall indemnify the other Member, the other Member's Representatives and the Company from any debts, liabilities, obligations, claims, damages, costs and expenses (including reasonable attorney's fees) arising out of or related to the indemnifying Member's operation of the businesses transferred to the Company prior to the transfer, except to the extent specifically assumed by the Company. Section 10.03 Insurance. The Company may purchase and maintain insurance on behalf of any person in such person's official capacity against any liability asserted against and incurred by such person in or arising from that capacity, whether or not the Company would otherwise be required to indemnify the person against the liability. SECTION ELEVEN TAX MATTERS Section 11.01 Tax Characterization and Returns. The Members acknowledge that the Company will be treated as a "partnership" for tax purposes. Within 90 days after the end of each fiscal year, the Company Manager will cause to be delivered to each person who was a Member at any time during such fiscal year a Form K-1 and such other information, if any, with respect to the Company as may be necessary for the preparation of such Member's federal or state income tax (or information) returns, including a statement showing each Member's share of income, gain, or loss and credits for such fiscal year for federal or state income tax purposes. Section 11.02 Tax Matters Partner. Harvest States shall act on behalf of the Company as the "tax matters partner" within the meaning of Section 6231(a)(7) of the Code. Section 11.03 Fiscal Year. The fiscal year of the Company shall end on the last day of August of each calendar year unless the Members unanimously agree to elect another fiscal year. SECTION TWELVE AMENDMENTS Section 12.01 Amendment of Agreement. No change, modification or amendment of this Agreement shall be valid or binding unless such change, modification or amendment shall be in writing signed by the holders of one hundred percent (100%) of the then outstanding Governance Rights. SECTION THIRTEEN UNWIND PROVISIONS; DISPUTE RESOLUTION Section 13.01 Triggering Events. If any of the following events occur, then this Agreement may be terminated and the Company dissolved in accordance with the provisions of Section 13.02, but only after engaging in the dispute resolution procedures described in Section 13.03: (a) If the relationship between the Members has deteriorated to the extent that they cannot continue to manage the Company together or if the Members are deadlocked on an issue which has a material adverse affect on the operations of the Company (a "13.01(a) Event"). (b) If either Member is in breach of any covenant or undertaking of Section 7.03 (a "13.01(b) Event"). (c) If Harvest States, except for Harvest States' existing operations set forth on Schedule 13.01 (c), fails to use the Company as its sole agent in the manufacture, wholesale marketing or wholesale sale of animal feeds or animal feed products in the United States (a"13.01(c) Event"). (d) If, without the consent of all other Members, any Member is a party to a merger or consolidation with a company having a net worth in excess of $ 15 million, or a sale of substantially all of its assets(a "13.01 (d) Event"). (e) If, without the consent of all other Members, any Member acquires or operates a business which does create, or has the reasonable potential of creating either a conflict of interest of, or use of confidential or proprietary information or knowledge or expertise of another Member by, such acquiring Member, either directly or through the Company, including without limitation by reason of administration of the Ingredients Purchase Agreement or the purchase of grain by or for the Company (a "13.01(e) Event"). Section 13.02 Dissolution Option. If a 13.01(a) Event occurs then either Member, if a 13.01(b) Event occurs then the non-breaching Member, if a 13.01(c) Event occurs then Land O' Lakes, if a 13.01(d) or 13.01(c) Event occurs then the non-consenting Member, shall have the option to terminate this Agreement and dissolve the Company (the "Dissolution Option"). The Dissolution Option shall be exercised by the appropriate Member by written notice to the other Member within 60 days after the end of the Dispute Resolution Period and dispute resolution procedures described in Section 13.03 if the Members have not resolved the dispute within the Dispute Resolution Period. Section 13.03 Dispute Resolution. If an event described in Section 13.01 occurs, the Members shall use their good faith efforts during a ninety (90) day period following the occurrence of the event (the "Dispute Resolution Period") to resolve the matter and continue to operate the Company under the terms of this Agreement. During the Dispute Resolution Period the Members shall attempt to resolve the matter in dispute by mediation between the President of Harvest States and the Chief Executive Officer of Land O' Lakes. If the Members have been unable to resolve the matter by the end of the Dispute Resolution Period, the appropriate Member may terminate this Agreement and dissolve the Company as provided in Section 13.02. Section 13.04 Dissolution of The Company. If the Company is dissolved pursuant to this Section 13, the leases and all other contracts between the Members and the Company shall be terminated as soon as commercially reasonable but in any event within 60 days following the delivery of the written notice required by Section 13.02. The remaining assets of the Company shall thereafter be liquidated in accordance with applicable law. The Members Representatives shall act as the liquidators. The proceeds from the liquidation of the Company's assets shall be distributed in the following order of priority: (a) First, to the payment of liquidation expenses and debts owing to creditors, in the order provided by law, except those expenses and debts owing to the Members. (b) Second, to the setting up of any reserves that the liquidators may deem necessary or appropriate for any anticipated obligation or contingencies of the Company. (c) Third, to debts owing to the Members. (d) Fourth, to the Members in accordance with their respective capital accounts. SECTION FOURTEEN MISCELLANEOUS Section 14.01 Governing Law. This Agreement and the rights of the parties hereunder will be governed by, interpreted, and enforced in accordance with the laws of the State of Minnesota. Section 14.02 Binding Effect. This Agreement will be binding upon and inure to the benefit of the Members, and their permitted successors and assigns. Section 14.03 Severability. If any provision of this Agreement is held to be illegal, invalid, or unenforceable under the present or future laws effective during the term of this Agreement, such provision will be fully severable; this Agreement will be construed and enforced as if such illegal, invalid, or unenforceable provision had never comprised a part of this Agreement; and the remaining provisions of this Agreement will remain in full force and effect and will not be affected by the illegal, invalid, or unenforceable provision or by its severance from this Agreement. Furthermore, in lieu of such illegal, invalid, or unenforceable provision, there will be added automatically as a part of this Agreement a provision as similar in terms to such illegal, invalid, or unenforceable provision as may be possible and be legal, valid, and enforceable. Section 14.04 Multiple Counterparts. This Agreement may be executed in several counterparts, each of which will be deemed an original but all of which will constitute one and the same instrument. However, in making proof hereof it will be necessary to produce only one copy hereof signed by the party to be charged. Section 14.05 Additional Documents and Acts. Each Member agrees to execute and deliver such additional documents and instruments and to perform such additional acts as may be necessary or appropriate to effectuate, carry out and perform all of the terms, provisions, and conditions of this Agreement and the transactions contemplated hereby. Section 14.06 No Third Party Beneficiary. This Agreement is made solely and specifically among and for the benefit of the parties hereto, and their respective successors and assigns, and no other person will have any rights, interest, or claims hereunder or be entitled to any benefits under or on account of this Agreement as a third party beneficiary or otherwise. Section 14.07 Notices. Any notice to be given or to be served upon the Company or any party hereto in connection with this Agreement must be in writing and will be deemed to have been given and received when delivered to the address specified by the party to receive the notice. Such notices will be given to a Member at the address specified in the Company's Required Records. Any Member or the Company may, at any time by giving 5 days' prior written notice to the other Members and the Company, designate any other address in substitution of the foregoing address to which such notice will be given. Section 14.08. Remedies. Any remedies provided herein shall be in addition to, and not in lieu of, any remedies available at law or in equity. In the event of a breach hereunder, the prevailing party shall be entitled to receive from the other party(ies) its attorneys fees reasonably incurred as a result of such breach. IN WITNESS WHEREOF, the parties hereto have signed this Agreement the day and year first set forth above. LAND O' LAKES, INC. HARVEST STATES COOPERATIVES By: /s/ Duane Halverson By: /s/ David Swenson ------------------------------- ------------------------------- its Executive Vice President its Senior Vice President ------------------------------- ------------------------------- EX-24 3 POWER OF ATTORNEY EXHIBIT 24 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 4 FINANCIAL DATA SCHEDULE
5 12-MOS MAY-31-1998 MAY-31-1998 33,635,720 0 207,689,447 11,985,000 210,895,285 500,656,701 477,031,065 222,555,877 945,703,463 398,202,123 177,610,625 0 0 0 414,003,905 945,703,463 5,507,394,461 5,607,449,565 5,464,036,841 0 62,311,965 2,041,498 17,442,718 63,658,041 6,400,000 57,258,041 0 0 0 57,258,041 0.00 0.00
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