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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
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[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
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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)
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SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT: NONE
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT: NONE
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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
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INDEX
PAGE
NO.
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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
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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,
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1998 1997 1996
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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,
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1998 1997 1996
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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
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1,145,851,767 1,280,557,384 1,692,438,700
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Sales of grain by the Company for each of the years ended May 31 are set
forth below:
1998 1997 1996
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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
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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".
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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.
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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;
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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